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Economic lesson - To fight inflation, it is necessary t...

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To fight inflation, it is necessary to fight protectionism

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Pinelopi Koujianou Goldberg, a former World Bank Group chief economist and editor-in-chief of the American Economic Review, is Professor of Economics at Yale University.

One of the most important benefits of free trade is that it exposes domestic firms (and labour markets) to greater competition, which induces them to keep prices low and to innovate constantly to stay ahead of the curve.

One of the main goals that US President Joe Biden has set for his administration is to empower US workers and the country’s middle class. Many believe that globalisation (along with several other factors) contributed to stagnating real wages, rising inequality, and the sense that US workers have lost out to workers in other countries with lower labour standards. But in its attempt to reverse these trends, the Biden administration has embraced protectionist rhetoric and policies that will cause US workers to lose once again.

Though any mention of the word “openness” is met with suspicion nowadays, the surge in inflation – the US Consumer Price Index was up 8.3% in April – has nonetheless prompted a discussion among economists about whether trade liberalisation (and openness more generally) could be used to rein in rising prices. Since one of the main arguments for free trade is that it lowers prices for consumers, the link between open borders and inflation is worth contemplating.

To be clear, no reasonable economist claims that the recent inflation is the result of trade restrictions. By now, the causes are well understood to be a combination of pandemic-driven supply-side shortages, policy-fuelled demand, and further supply-side disruptions caused by Russia’s war in Ukraine. But as policymakers struggle to contain inflation without causing a recession, they must recognise that “Buy American” requirements, tariffs, and immigration restrictions may be making a bad situation worse.

According to a recent Peterson Institute for International Economics (PIIE) policy brief, a feasible reduction of trade barriers “could deliver a one-time reduction in [CPI] inflation of around 1.3 percentage points”. The study is conservative, focusing only on trade restrictions that can plausibly be lifted in the short term, and its authors are careful to emphasise that the result would be a one-time outcome. The proposed reduction of trade barriers would not solve the problem of rising prices, but it would make today’s high prices lower.

US consumers would welcome such short-term relief. If the Biden administration finds it necessary to sell oil out of the Strategic Petroleum Reserve despite its commitment to addressing climate change, why shouldn’t it also recognise the need to reverse Donald Trump’s tariffs? In 2021, according to the PIIE brief, these duties still applied to more than half of US imports “subject to high tariffs, penalty duties, or severe quotas”.

Perhaps more importantly, openness, whether it is free trade or immigration, also contributes to consumer welfare in indirect ways. Though these effects are often hard to quantify, they are of first-order importance, which is why economists often turn to first principles when debating them.

One of the most important benefits of free trade is that it exposes domestic firms (and labour markets) to greater competition, which induces them to keep prices low and to innovate constantly to stay ahead of the curve. Similarly, immigration eases labour-supply shortages, and high-skilled newcomers can boost productivity and innovation. Forward-looking countries understand this and embrace immigration. The UK, for example, has adopted a new skilled-worker visa programme that welcomes graduates of top global universities.

It is deeply misguided to restrict trade and immigration at a time when rising domestic prices are of paramount concern. Now that everyone is fixated on inflation, it is worth considering why inflation was so low these past two decades, despite full employment in the US (prior to the pandemic) and despite ultra-expansionary monetary policies. Globalisation (now a loaded term) arguably had a lot to do with it, as did automation (another loaded term).

The prospect of outsourcing jobs to lower-wage countries or to machines constrained workers’ bargaining power. At the same time, foreign competition constrained domestic firms’ pricing power (though there is ample evidence that the cost reductions they achieved by globalising production still allowed them to make hefty profits).

Workers and firms face a different reality today. Their jobs and businesses seem more secure now that the US has turned inward and embraced protectionism. The “Great Resignation” and other developments have reduced the supply of workers, increasing the bargaining power of those still in the labour force.

This could be a positive development, except that the high inflation rate has undermined efforts to make the average US worker better off. While nominal wages in the US rose by 5.6% in the year ending in March (more than an extrapolation of the earlier trend would have implied), that month’s 8.5% inflation rate implied that real wages fell by 2.7%.

If there is any silver lining to today’s inflation, it lies in the lessons that this episode has provided to policymakers and the public alike. Because the benefits of open borders (lower prices) are less salient than the costs (lost jobs or lower wages), and because consumer interests are not organised, while worker interests often are, there is a bias toward protectionist sentiment. Today’s inflation highlights the need to resist this bias.

The current decline in real wages is a reminder that our wellbeing depends not only on the nominal wages we earn as workers but also on the prices we pay as consumers. Open borders can help keep prices low during a challenging time. Reversing the tariffs imposed by the Trump administration would be a step in the right direction. DM/BM

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All Comments 3

  • I’d rather pay ten cents for for a local product if it means more of my people are employed. There are well known arguments for the value of protectionism for developing economies, such as South Korea. In fact there should be more capital controls and labor protection rather than opening everything to the fattest cats for whom alone the market is ” free.” The bigger they are, the more they have to have, like two equally matched parasites attached to a struggling tree. We need to get over our self delusions and think appropriately small to our cosmic and mortal size.

  • A sermon from the pulpit of neoliberal orthodox religion. Here’s some heresy:

    Free trade benefits traders between separate social economies, but degrades producers of materials and services being traded. Currency extracted from commercial exchanges is taken from the providers of material for the trades.

    Merchants guarantee themselves extraction of currency from the commercial exchanges they mediate and control. But each such trade parasitises the producers of the materials traded, and they are progressively impoverished. That’s the inevitable and observable consequence of global free trade.

    In an exchange of equivalent goods, when ‘home’ production is eliminated, those erstwhile products become rare and of high worth.
    Lowering the prices paid to the ‘away’ versions, by reducing wages to below living standards, not mitigating the harms caused by their productive processes, skimping on essential maintenance, neglecting safety of employees from hazard, and other cost of production reductions, maintains the high differential between ‘home’ and ‘away’ prices, thus guaranteeing merchants maximal currency profits. This is the social mechanism to “keep prices low”.

    Protectionism is a way of ‘home’ governance attempting to reverse this trend.

    “… consumer interests are not organised, while worker interests often are …”
    Consumer interests are organised through persuasive advertising by merchants to make people pay through artificial enhancement of product value. Brand preference adds nothing tangible to the worth to the consumer, and is a price addition, a persuaded belief, an übertax on gullible consumers. This is a systematically manipulated market.

    Commercial corporations expend great efforts to prevent workers organising effectively, predominantly successfully in the neoliberal world.

    Since governance has globally been captured by merchants and their corporations, there can be no interference in this system of plundering to mitigate the harms it is causing.

    The antidote to enforced mercantile governance is socialism, so it must be destroyed wherever it arises, and invariably is. People should not be allowed to combine to govern themselves, so it is prohibited, outlawed, sabotaged where free trade is the rule.

    • Thank you, Bobmarsden. Well said.
      It’s all very well for the developed economies, who developed their economies with high levels of protectionism, to now spread the gospel of free markets – when they dominate the markets in added-value products and intellectual property. The less-developed nations are left with the low-value primary products that feed the industrialised world. They are expected to compete on a playing field that is well off level, and tilted precipitously in favour of the more-developed economies.
      “A sermon from the pulpit of neoliberal orthodox religion”. Indeed.

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