Trade Sequence Part 4 – The Race to the Bottom
So, I’m doing this again.
I thought it was high time I returned to my Trade Sequence, I can’t spend the whole time enjoying Wellington abnormally good summer weather.
In light of the recent discussions about sweatshops / working conditions in developing countries, I’ve decided to expand what I was going to say about that into a full post.
The new Contents page is as follows:
- Introductions and Definitions
- They took our Jobs!
- The Tribulations of the Working Class
- The Race to the Bottom (you are here)
- The Rich Man’s Burden
- Getting Strategic
- You will be Assimilated
Feel free to ask me about any other trade-related question. I will do my best to get to them some time before the heat death of the universe.
Thus far, I have only really looked at the effects of a single country’s trade policies in isolation, but this is clearly a limiting perspective from which to consider trade policy. Unlike domestic policy, foreign policy has to be evaluated strategically, considering how other countries will react. One argument I often hear from people is that while in an ideal world every country would have free trade, some countries cheat by having poor labour or environmental standards and if we don’t restrict trade with them they’ll gain an advantage. Some go so far a to suggest that this could lead to a “race to the bottom” where every country undercuts its own standards to maintain competitiveness until we’re all nothing but serfs working 12 hours a day while standing in toxic waste up to our armpits.
This argument is based on a misunderstanding of what it means to have a competitive advantage in trade. People tend to naturally assume trade works through Absolute Advantage, that you export the things you make better (or cheaper) than other countries and import things they can make better (or cheaper) than you. So a country with looser labour or environmental standards will have lower production costs and will end up producing more and more of the world’s goods, until other countries are forced to lower their standards to compete.
The problem is that Absolute Advantage isn’t what defines trade patterns – Comparative Advantage is. Comparative advantage is hard to explain without a whiteboard and 15 minutes, but here’s my best effort:
- Absolute advantage is where you export what you can make better than any other country.
- Comparative advantage is where you export what you can make better than any other good.
This is a fundamentally important difference. For one thing it is possible to have no absolute advantages, but you always have comparative advantages so there’s no way to find yourself without some export markets.
You might think that sounds damn convenient, how can I blithely assert that perfidious foreigners can’t just out-perform you in everything? The key here is that trade is fundamentally an exchange of goods for goods – money is just an economic lubricant. If one country is exporting a lot of goods to another county, but getting none back then what is the exporting nation getting out of the deal? To put it in monetary terms a lot of people want to buy the exporting nation’s currency (so they can buy its products), and a lot of people want to sell the importing nation’s currency (because they keep being paid in it for exporting to that country). This makes the exporting nation’s currency stronger (making its goods more expensive), and the importing nation’s currency weaker (making anything they produce cheaper). In other words, any advantage the country with low standards racks up gets eroded by international currency flows.
That’s not to say that environmental and labour standards have no effect on trade patterns. While cheap labour may be beneficial in any industry, it benefits some industries more than others. The more labour-intensive an industry is, the more cheaper labour benefits it. Looser labour standards also help more in risky or unpleasant jobs (where there’s a bigger difference between good and bad workplaces), and jobs with low skill workers (high skill workers will have more leverage to get good pay and conditions without the government’s help). So countries with loose labour laws will disproportionately attract industries that require large numbers of low-skill workers and which have potentially dangerous or unpleasant conditions. At the same time those with stronger labour laws will disproportionately attract industries with the opposite characteristics. Equally, countries with low environmental standards will attract highly polluting industries, at the expense of less-polluting ones.
Fundamentally, there is no race to the bottom implied here. Instead each country accepts whatever trade-off its comfortable with on labour standards and the environment, and the patterns of trade emerge accordingly.
So does this mean labour and environmental standards have no economic cost? Well, no. For one thing the internal changes they causes in an economy can generate political resistance (the movers and shakers in a now-dying industry are going to try to push back). Plus there is the persistent fallacy that a country can be analogised to a gigantic company, and that it is important for that company to be “competitive” with the rest of the world. But your problem there is bad economics, not trade itself.
More seriously, there are some non-trade issues with high labour / environmental standards. If minimum wages and mandated amenities cost more than the output you can expect to get from a given worker, then you won’t hire that worker. More broadly, if environmental and labour restrictions make running a business too expensive, that business will go bust. Now, that may well be a price worth paying, and on balance the richer a country is (and therefore the higher productivity its workers and businesses are), the less harm you would expect to see from a given regulation so it’s best not to freak out about it too much, as long as you keep the relevant trade-offs in mind.
This point will be relevant to the next part, where I discuss conditions in poor countries.