Until very recently, very few people were questioning the paradigm of the benefits of the free trade for our society. Those who were openly expressing opinions against the free trade were considered as uneducated and unworthy of any attention. However, that state of mind began to shift extremely rapidly and unexpectedly. Since TAFTA negotiations have been halted, the United Kingdom is leaving the European Union and Donald Trump is on the breach of being elected the United States president, it is perhaps the right moment to do an introspection of the concepts in which we thoughtlessly believe…
Lately, the famous recipient of the Nobel Prize of Economics, Joseph Stiglitz was grading Donald Trump with an “F” for his understanding of Economics and his stance regarding the free trade. Mr. Stiglitz argued that despite the fact that some American citizens become unemployed due to the outsourcing of production means to the developing economies, they can still benefit of cheaper imported goods. Therefore, if Donald Trump becomes president, puts his plan to actions and starts imposing importation fees on Chinese products, not only China will take retaliating measures against the United States at the World Trade Organization, but Americans will also lose of their buying power due to a significant increase in prices. Additionally, according to Mr. Stiglitz, these measures would not bring any manufacturing jobs back to the United States, as it lost its competitive advantage in that field. On the contrary, a dispute with China will induce even more unemployment.
The underlying conclusion is that despite the fact that the free trade offers some disadvantages, our society is better off with the free trade. Nevertheless, the situation is not as straightforward as this conclusion seems to suggest. Recent empirical research studies seem to indicate that the real conclusion to that complicated question (as usual in Economics) should be — “it all depends”.
Why the free trade might not be optimal…
On the aggregated level, we, as a society are indeed, better off with the free trade. We have a much bigger choice of goods than we used to and more importantly, we pay our goods cheaper than we would if we were living under trade barriers. However, once you start going into details and analyzing the situation at the individual level, the outcome actually greatly depends on which social class you belong to, in which region you live and which basket of goods you consume. As it appears, the decrease in prices resulting of the free trade is far from being homogenous.
First of all, it appears from empirical studies that the decrease in prices is not systemic. Some goods decrease in price, some goods keep the same price whereas others might even increase in price due to the free trade. However, on the aggregated level, consumers can purchase similar goods for cheaper due to a larger choice of substitutes. Additionally, as some prices decrease and others increase, consumers can consume the same or even a higher quantity of goods by reallocating their income differently.
Secondly, the benefits of free trade are not distributed equivalently across all the layers of the society. If you belong to the middle class, or to the upper middle class, then indeed, you benefit a lot of the free trade. You can purchase your clothes, your computers, your smartphones, TVs, cars, toys and basically any other manufactured good, cheaper. This situation leaves you with much more money to spare or with the possibility to consume more goods. The free trade makes you benefit of the income effect and, thus, without even earning more you are able to spend more. Congratulations, you are the big winner of the free globalized world.
However, if you belong to the lower social classes, empirical studies show that you benefit from the free trade, but significantly less than your wealthier nationals. Comparison plays a significant role in the perceptions of the utility levels. If you gain more than you used to, but in comparison, less than others, then you might have a biased perception of being worse off despite being actually better off. In our case, we do not only have that perception bias, but we also face the fact that citizens with a lower income, increased their endowments by only 0.5% on average thanks to the free trade, compared to more than 5% for the wealthiest individuals, according to the economist Sergei Nigai. This gap is even higher in the developing countries. Therefore, even a 1% increase in wealth is hardly perceptible, especially, if it is spread in time. Unsurprisingly, the typical voters of the populist politicians, such as Donald Trump belong mainly to the lower income classes.
The issue resides in our 2 main monthly expenditures….
While the prices of manufactured goods decrease, the free trade inflated the prices of other goods, such as the staples. The prices on food have increased dramatically since the nineties, as markets became more liberalized. It is not an issue for the middle class as the proportion of income that they allocated to their groceries remains reasonable. However, it is a terrible situation for people who have a low income and for whom food represents one of the biggest monthly expenditures. These people clearly lose their buying power and even worse, become poorer each year.
Researchers emitted the hypothesis that food becomes more expensive due to the fact that nobody really has a competitive advantage in food production. The technology remains marginally the same and there are very few differences between the techniques that countries use to produce food. The existing marginal differences in prices are being absorbed by the processing and the transportation costs. Moreover, it is also probable that as people view food as a small expense and have the financial means to consume more thanks to the free trade, they tend to purchase more than what they could actually consume.
Housing is the other main expense of the households and it has also been subject to dramatic price increases. According to the researchers, the price increase in the housing fees is mainly due to the fact that people have a higher residual income. As households spend less on manufactured goods, they have more money on hands. Thus, a part of these extra funds is captured by landlords who can charge higher rentals without losing their tenants. As long as there is space to increase prices without decreasing the demand, prices will naturally settle higher.
Once again, the situation does not seem abnormal to the middle classes who are mainly owners of their own houses and do not feel exceedingly impacted by the housing price increase. However, the situation becomes unbearable for the lower income individuals whose main monthly expense is their rent.
Free trade — the creator of inequalities…
We already knew the free trade contributed to the outsourcing of most of the manufacturing jobs to the developing countries due to the removal of trade barriers and a combination of a cheaper labor, low transportation costs and lax regulations. Thus, it is certainly not a surprise that one of the reasons why we have such a high unemployment in the Western countries is the free trade. It is assumed that as soon as a country loses its competitive advantage, the outsourcing and the resulting unemployment are unavoidable.
However, the free trade arguably offers a substantial compensation to the unemployment, under the form of lower consumption prices. Nevertheless, it is the unexpected combination of the two negative effects of the free trade, namely, the unemployment and the increase in prices of the vitally essential goods that makes us reconsider the benefits of the free trade. The results of the recent researches make us realize that the free trade might actually increase social disparities and leave a big part of the population completely hopeless.
Fighting the populist ideas…
It is thus unsurprising to see people turning themselves towards the politically unexperienced populists who promise them to restore the life conditions that they used to have before the expansion of the free trade. It becomes clear that the free trade presents several negative effects that must be urgently addressed. Until recently, our politicians could afford the luxury of neglecting these problems and let the social inequalities rise. However, today people use their vote to raise awareness regarding the social problems that the free trade might provoke. Arguably, one of the reasons why Brexit occurs, is because of these negative spillovers.
Nevertheless, it is important to emphasize that politically unexperienced demagogues do not bring any tangible solutions with respect to how to halt these inequalities. The only solution that they proposed so far is a nearly complete isolation from the developing countries. It is clear that if we opt for the restriction of the free trade, all the consumption prices will rise, whereas these measures will induce nothing but negative effects on the employment. Thus, with the rise of populists, we can expect being transposed from the situation where a part of the population is worse off, to a situation where most of the population will be worse off.
Therefore, this situation must be addressed as soon as possible in order to stop the expansion of populist movements. The only potential solutions for the politicians seems to be working on a much more fair and efficient wealth distribution. It is crucial for our society to provide people with a sufficient access to housing and food regardless of their income, especially on the dawn of a phenomenon that should have a much bigger social impact than the free trade — the industrial automatization.
The new researches show us once again the importance of going into the details. The aggregated picture might seem bright, but once we analyze specific situations, we realize how important it is to take each case individually. There is a significant number of voters who felt neglected by the governments. Despite the evidence that the life conditions of a significant part of the population deteriorated, politicians kept saying that the free trade makes all of us better off. Thus, these people voted accordingly for the only people who seemed to listen to them — the populists. People used their voting right to drag attention to their deteriorating life conditions. Politicians should use the results of the resent research studies to correct the negative effects of the free trade and alleviate the inequalities. Today, we can only hope that it is not too late for a significant policy shift on behalf of the politicians to avoid a catastrophe during the upcoming elections.