As the world hovers on the brink of a global trade war, we need to think about how we got here and what we can do to step back. Escalating tariffs between the United States and China, and President Trump’s attempts to renegotiate the North American Free Trade Agreement (NAFTA) are responses to the deeper problem of the costs of structural change.
These costs come in the concentrated loss of jobs in some regions and skills types – and have predominantly hurt middle-income men in regional communities and their families. Australia is not immune from the pressures of structural change.
Economists are belatedly recognising that while opening trade brings substantial gains to the domestic economy, not everyone benefits directly, and those who are not better off do not see why they should support a system that does not advantage them.
Even if people can be convinced they are better off because the things they consume are cheaper, and governments have used the revenue from taxes to provide more services, relativities matter. People tend to associate trade with lost jobs, but not with lower prices, which increase the real wage. And the gains from trade and technology are seen to be captured by the better educated, which contributes to a widening wage gap.
These perceived concentrations of the gains from trade and technology are partly right – exporting firms and tech leaders pay higher wages. The OECD estimates that about 5 per cent of firms account for almost all productivity growth. The more churn there is in the firms that make up this top 5 per cent the more the gains will be spread.
But lately this churn has declined. Fewer firms are capturing a larger share of growth. As the wage premium for workers in these firms grows, and more workers compete for jobs at the other end of the spectrum, the distribution of income has widened. This trend has seen real wages for workers below median income stagnate in the United States for over a decade. And in Australia real wage growth has been moribund, stalling for men in full-time work since 2014, falling 11 per cent for men in part-time work between 2013 and 2016, and declining 6 per cent for causal workers.
It is hard to separate the effects of trade and technology in widening wage – and income – inequality. China’s entry into the World Trade Organisation in 2001 resulted in a massive increase in world trade. Some decline in US manufacturing is undoubtedly due to the rise in exports from China, but manufacturing employment was already falling as robots replaced workers.
In Australia the decline in trade protection (tariffs and quotas) in the 1980s and 1990s has been linked to the decline in manufacturing employment. But manufacturing output grew 2.4 per cent a year between 1994 and 2001, the Productivity Commission found, while manufacturing employment was steady. The link between manufacturing output and employment has clearly changed – so efforts to turn the clock back through protection will not restore well-paid jobs to middle-skill men.
The view that trade protection is the answer is dangerous, because it takes government off the hook for helping people harmed by structural change. It is dangerous because protecting firms and industries allows them to be less efficient, sapping productivity and hence income growth. It is dangerous because it undermines the global trading order – the rules that reduce the costs of trade and investment, ensure that contracts can be enforced, and help firms be treated fairly. And it is dangerous because trade and investment are the best ways to assist developing countries to grow their economies, move their people out of poverty and stem the flow of refugees.
So why is social protection better than trade protection?
First, trade protection does not bring back jobs; it only slows the loss of jobs in protected industries. A few workers will benefit, but at a cost to others in industries that face higher costs. This hits industries that rely on imported inputs and technologies, hurting the very firms that tend to drive productivity growth. Trade protection drives up the cost of living as the price of traded goods rises. This hits young families and people forming households the hardest as these products form a larger share of their budget.
Second, the challenge is to ensure the gains from trade and technology are shared so people have reason to support open markets for goods, services and capital. Social policy – such as spending on income support, health, education, transport and urban amenity – compensates those who are not winners and improves their capacity to join the winners. It is this creation of opportunity that underpins the social compact to support open markets.
Third, trade protection reduces government revenue. If this translates into less spending on social services, then protection is a double whammy. Where the effects will be felt depends on how governments decide to respond to lower revenue, but ultimately some, and likely many, groups will be worse off. Trade protection helps a few at a cost to many, exacerbating the problem that led people to support such misguided policy.
Australia has a heavily redistributive social policy: progressive income tax, means-tested income support and the provision of services. Tax and transfer policies reduced household inequality by 31 per cent in 2015-16, according to the Productivity Commission. Even in the United States, social insurance has played a major role in reducing inequality. Real household income for the bottom quintile grew by 26 per cent between 1979 and 2014 before taxes and transfers, but 69 per cent after them, according to the Congressional Budget Office.
Getting social policy right is tough. Governments worry about designing income support so it does not undermine incentives to acquire skills and to work. They worry about ensuring that quality services are provided to those who cannot afford them, about when universal service access will work better than conditional access, and about whether to take place-based or more general approaches. And they worry about how to fund these services.
Governments know not all policies will benefit all people, and that sometimes people will be worse off. They need sound evidence to make policy choices, and where they don’t know they need to be able to test options and change policy when it is not achieving its objectives. And citizens need their governments to explain the policy choices they make.
Social protection, not trade protection, means we can all share the gains from open trade and new technologies.
An edited version of this article appeared in the Public Sector Informant on 6 November 2018.
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Written by Nous Group's Chief Economist, Jenny Gordon