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Global Trade and Conflicting National Interest

"Our objective," Baumol told a policy conference last summer, "is to show how outsourcing can indeed reduce the share of benefits of trade, not only for those who lose their jobs and suffer a direct reduction in wages but can wind up making the average American worse off than he or she would have been."

Even if times ahead are troubled, the long run is likely to look much more settled. In the short run, a housing slump could well make private investors and central banks outside the U.S. less eager to hold dollars. A survey by the U.S. Treasury Department last year indicates that about third foreign-held U.S. corporate debt consisted by asset-backed securities and about half of that was mortgage-related. Petro-dollars held in the Middle East and Russia are particularly mobile. Once foreign money leaves the U.S., the dollar would fall. In the longer run, U.S. exports would rise, shrinking the huge U.S. trade deficit. Moreover, recession in the U.S. would lead to lower imports, further reducing the trade deficit. At the same time, China may well let the yuan rise against the dollar, leading to a rise in its domestic spending relative to its exports. Once U.S. consumers spend less and Chinese consumers spend more, the large global imbalances, which have cast a shadow on the world economy for the past decade, would begin to disappear.

All of the countries that do this are better off than they would be without international trade. But even though it is possible to prove mathematically that this is true for nations, it is not true for every group of people within nations.

Yet even if one agrees that a country has a right to restrict immigration, it does not follow that it ought to do so. Mr Legrain argues that it is not just in the global interest to have free migration, but also in that of recipient countries. A standard “gains from trade” analysis would suggest that this should be true. But if one is to argue for free movement of labour on economic grounds one needs a sense of the likely consequences. Analyses of free migration in the presence of huge real wage differentials suggest that we would end up with vast informal sectors and shanty towns. That is what happens within poor countries. Why should it not happen across the globe? I cannot see how one would persuade a host population that this outcome would be in their interests.

I believe (as I argue in my book The Soulful Science) that economics offers a uniquely powerful way of thinking about society, and how individuals make choices in their social context. Other approaches, those of the other social sciences, or history or literature and music, are valid too - I feel no need to dismiss them. But only economics with its choice-based models emphasises the opportunity costs and trade-offs that inevitably arise from the social and physical realities of our existence.

The Energy Department's Office of Energy Efficiency and Renewable Energy funds research at national labs and private companies, and recently offered $4 billion in loan guarantees to 16 clean-tech companies, including three in or near Silicon Valley. It also helps sponsor trade missions to China and India that have included energy start-ups, such as MiaSole, a Santa Clara solar-cell maker.

Economists distinguish between “Risk” and “Uncertainty”: the former can be priced by financial markets while the latter cannot. The distinction between the two was made by the famous economist Frank H. Knight in his seminal book, Risk, Uncertainty, and Profit (1921). In brief, “Risk is present when future events occur with measurable probability” while “Uncertainty is present when the likelihood of future events is indefinite or incalculable”.    This distinction between risk and uncertainty helps to explain the recent market panic and turmoil. Today, the FT cites a market economist at Lehman who said: “We are in a minefield. No one knows where the mines are planted and we are just trying to stumble through it”. A few days ago another market participant put it this way: “It is not the corpses at the surface that are scary; it is the unknown corpses below the surface that may pop up unexpectedly”.   Unknown minefield; unexpected corpses: this is “uncertainty” rather than “risk”. Risk can be measured and priced because it depends on know distributions of events to which investors can assign probabilities. Uncertainty cannot be priced by markets because it relates to “fat tail” distributions and extreme events that cannot be easily predicted or measured.

A few days ago the CFO of Goldman Sachs justified the massive – 30% plus  - losses of the two Goldman Sachs hedge funds by arguing that these were unpredictable “25 standard deviation events” that should occur only once in a million years. The same thing was said by the LTCM “masters of the universe” when their highly leveraged hedge fund went belly up in 1998.

The proliferation of such products, as I have often noted before, carries many benefits for the financial system (most notably that they disperse risk across a much wider pool of investors). But this trend also carries at least one downside; it is adding to the opacity of the financial world. For although many corners of the structured credit universe are becoming more transparent, almost as soon as one chink of light emerges, another shadowy wave of activity emerges that is far more opaque.