Brad de Long joins the debate over the gains from trade, responding to earlier posts by Kieran Healy and me, with a typically thoughtful and thought-provoking contribution.

I’m hoping this will be the start of a sustained debate/discussion, and I’m going to start by responding to a simple point. Brad says “1.24 percent of current consumption is nothing to be sneezed at ” and he’s right. It’s about $A 8 billion per year, which is a lot of money. For example, assuming government got about half of the gain this would be enough to restore most of the cuts made to post-secondary education over the past decade.

Brad goes on to make an argument I’m less happy with.

In the context of the Australian economy today… Gourinchas and Jeanne’s numbers say that (at a five percent per year safe real interest rate, and with a three percent per year economic growth rate) the value of international capital mobility to the Australian economy is on the order of a one-time present of some 400 billion $A.

To spell it out, with Brad’s numbers the present value of any flow that grows in line with GDP is fifty times (1/(.05-.03) its initial annual value. Multiply the initial $8 billion by fifty and you get Brad’s $400 billion.

I have two problems with this. The first is that, with such a low effective discount rate (2 per cent) a lot of these gains accrue a long way in the future (about half the PV refers to the period after 2040) and I think the impact of any given policy change is hard to predict that far into the future. For example, it may turn out that an approach taken to capital market liberalisation today turns out in 20 years time to preclude some better arrangement that would yield greater benefits.

The second is more important. Suppose, you think there are costs of capital mobility that outweigh the 1 per cent benefit. To take a really simple illustration, suppose you believe that capital mobility destroys national pride and that national pride is worth more than $8 billion per year. It doesn’t alter the argument to say that the benefit of capital mobility in PV terms is $400 billion. If your willingness to sacrifice consumption for national pride is proportional to your income, as seems reasonable, the cost of giving up your national pride can be multiplied by the same factor of fifty to get a present value greater than $400 billion.

The present value conversion is only useful if we are comparing a long-lived flow of benefits to a once-off cost, for example, the need to shift workers into more capital-intensive industries to take advantage of a capital inflow.

An issue where this kind of comparison is important is that of the cost of squeezing inflation out of an economy. Monetary hawks sometimes argue that you shouldn’t worry too much about the unemployment and loss of output associated with a very tight policy because the present value of a permanent reduction in inflation will nearly always outweigh any temporary losses.

I disagree for a couple of reasons. From my first point, I doubt the claim about permanence. The contractionary policies of the 1980s have been followed by a decade or more of low inflation, but it’s easy to see the possibility of a resurgence in inflation in a few years time, particularly in the US.

On the second point, it’s not at all clear that the economy returns to its long-term growth path after a recession. There’s clearly some rebound in the typical recovery, but if you look at an economy like New Zealand, where hawkish monetary policy produced a series of recessions in the 80s and 90s, it seems as if a fair bit of the output loss is permanent, or at least long-lived. There are similar points to be made about unemployment and hysteresis.

Kieran Healy links to a paper by Pierre-Olivier Gourinchas and Olivier Jeanne in which a calibrated growth accounting model is used to show that the gains from unrestricted capital mobility are likely to be of the order of 1 per cent of GDP. Gains from risk sharing aren’t mentioned but other papers are cited to say that these are of a similar magnitude.

Those who listen to the general pronouncements of economists might be surprised by the modest size of the estimated gains. But for those who have looked at similar exercises in the past there is no surprise here. One of the better-kept secrets of economics is the fact that most studies suggest that the replacement of a typical high-tariff regime (say Australia’s in the 1960s) will yield long run benefits of about 3 per cent of GDP.

Those who raise questions about this point are likely to be brushed off with a reference to supposed dynamic gains, not captured in this ‘static’ analysis. This brings us to an even better-kept secret. These ‘dynamic gains’ have about as much basis in neoclassical economic theory as the Tooth Fairy.

To complicate matters a bit further, there is a theoretically respectable category of dynamic gains, arising from the removal of distortions in intertemporal resource allocation, but these are even more modest than the static gains. In fact, the gains looked at by Gourinchas and Jeanne.

The last line of defence is the idea of X-efficiency, or the ‘cold shower’ effect of competition. As Chicago stalwart George Stigler was the first to point out, this idea is based on the fallacious assumption that additional work effort is costless. This fallacy is hard to kill, but anybody who’s experienced 1990s-style ‘workplace reform’ knows it for what it is. I’ve been hammering away on this point for at least a decade, for example here and here (PDF), but with very little impact.

I’ve been reading Clive Hamilton’s Growth Fetish on which quite a few bloggers have already commented. I agree with some of the points Clive makes and disagree, sometimes strongly, with others. I may do a full length review some time, but for the moment I’ll post a bit at a time.

I’ll start with a point of disagreement. Clive dismisses traditional social democratic concerns with absolute deprivation as being relevant, at most, to those in the bottom 10 per cent of the income distribution.

Taking food as the most basic necessity and the US as the developed country where social democracy has lost most ground, I looked for stats and found this briefing by the US Department of Agriculture. The key finding:

89.3 percent of U.S. households were food secure throughout calendar year 2001. “Food secure” means they had access, at all times, to enough food for an active, healthy life for all household members. The rest (10.7 percent) were food insecure at least some time during the year, meaning that they did not always have access to enough food for active, healthy lives for all household members. In 3.3 percent of all households, one or more household members were hungry at least some time during the year. The remaining 7.4 percent obtained enough food to avoid hunger using a variety of coping strategies such as eating less-varied diets, participating in Federal food assistance programs, or getting emergency food from community food pantries.

The figure is close enough to Clive’s 10 per cent, but this is a one-year snapshot. Since people move into and out of poverty, it’s clear that the proportion of Americans who have problems feeding their families at some time in a given period of say, five years, is well above 10 per cent. And this is using a very tight definition of deprivation at a time when the US economy, though past the absolute peak in 2000, was still doing very well by the standards of the last two decades. I’d say that the traditional social democratic concern with poverty is not yet obsolete.