Saturday, November 25, 2006

Losses from Trade

Economists spend a lot of time thinking about the gains from trade a perhaps not enough considering the losses. Creative destruction not only wipes away quasi-rents from innovation and market dominance but returns to human capital and possibly infrastructure as well.

Suppose that a worker has built 20 years of human capital in the manufacture of textiles. He knows everything there is to know about the types of cloth; machines; work train-up times need to produce fabric. He even has an intuitive knowledge of his factory and the way it responds to increased workloads, weather changes, even athletics. Workers in his town are riled up when regional football team is hot and he knows how to translate that into increased productivity.

Partially as a result of this human capital the factory he works in is among the most productive in the world and despite the fact that it pays high wages it has been competitive in the global economy. Yet, now the removal of some of the last trade barriers has tipped the equation in favor of an Indian firm. The rival is not nearly as productive as his firm. The workers require twice the raw materials and three times as many man-hours to produce the same fabric.

Yet wages are so low in India the rival firm has taken the edge and his shop is about to be closed. Everything that he has learned, has devoted his life to for the past 20 years is now gone, worthless in the new economy. He is adjustment cost. He is life is the deconstructed portion of creative destruction.

This is not a plea for protectionism but for awareness. The very same dynamic market that makes the human capital possessed by 25 year-olds in Silicon Valley worth six-figures makes the human capital possessed by 45 year-old factory foreman worth next to nothing.

In a world were productivity is determined primarily by physical capital these concerns are less important physical capital employed in sectors where the nation has a comparative advantage adds to the productivity of workers where they can benefit the most. However, in a world run by non-reversible, appreciating (reverse depreciation) human capital removal of an industry represents a permanent loss.

When I have more time I want to formally model what happens to individual welfare in a world where human capital is appreciating (on the job skill building) and a new trading partner is established that eliminates an old sector. My guess is that trade is still a net bonus though the effect is significantly mitigated and there is a strong redistribution in favor of human capital heavy participants in the sector with a comparative advantage.