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How do we know what we know about economics?

Posted By Russ Roberts On March 12, 2008 @ 5:00 pm In Data,Trade | Comments Disabled

I was asked the other day by a reporter if NAFTA had been a good thing or a bad thing for America. I said that both the proponents and opponents of NAFTA had no legitimate, unassailable or even suggestive, statistical evidence on their side. I said it was absurd to think that in a $14 trillion economy, you could tease out the impact of increased trade with Mexico and Canada and disentangle it from the thousands of other changes going on.

I suggested that anyone who provided an empirical case for or against the agreement was essentially being dishonest–using statistics selectively to make the case for a pre-existing world-view.

The reporter found this viewpoint unacceptable. Surely, he said, economics can help us answer the question of whether NAFTA has been good for America or bad. Or at least good or bad, for say Ohio.

I said no, there was no empirical evidence that would be decisive. It isn’t just that it’s hard to measure the net impact precisely. I argued that it can’t be measured.

He refused to accept this answer. Surely I could answer the question of NAFTA’s worth. I was just ducking the question.

I said, no, I wasn’t ducking the question. I was answering the question. He just didn’t like my answer.

But he couldn’t accept the answer as being "I don’t know," or more accurately, we can’t know if by "know," you mean some kind of defensible statistical evidence.

The most well-known think tank that views NAFTA negatively, the Economic Policy Institute [1], argues that between 1993 and 2004, Ohio lost 49,886 jobs because of NAFTA.

Not 50,000, but 49,886.

For the U.S. as a whole, EPI estimates that 1,015,290 jobs have been lost. Not a million, but 1,015,290.

But it’s not just the precision of the estimate that makes the calculation ridiculous. It’s the methodology that measures jobs displaced (the verb the EPI study usually uses) by assuming that imports destroy jobs and exports create jobs. With this methodology, a trade deficit reduces the number of jobs.

By this logic, America would have fewer jobs if foreigners suddenly decided to give us cars rather than selling them to us. Free foreign cars would destroy jobs in the American car industry. Inexpensive foreign cars do the same thing. So do cars made by Americans that are produced with robots instead of human welders. If you believe that imports destroy American jobs, so does better technology that makes workers more productive.

If the EPI was as anti-technology as they are anti-trade deficit, they could go out and measure the number of buggy manufacturing jobs destroyed by the auto industry and the number of eyeglass manufacturing jobs destroyed by lasik surgery or the number of jobs in the medical profession destroyed by pharmaceutical innovation. Surely those numbers could be estimated with some rough accuracy.

And surely they would tell us nothing about whether the world is a better place because of those innovations. And they would tell us nothing about the impact of those innovations on total employment.

But most of us understand that higher productivity doesn’t mean fewer jobs in the United States overall. There are two ways to see it. One is to see the increase in the total number of jobs over time as we have replaced people with machines in every corner of the economy where it’s possible. So this suggests that technology doesn’t destroy jobs.

The same is true of the apparent effect of trade deficits. Manufacturing employment was shrinking as a share of the total employment between 1950 and 1975 when the trade deficit was essentially zero. We run a trade surplus in agriculture. Yet agricultural employment shrinks rather than rises.

There appears to be no relationship between the number of jobs in America (or in Ohio for that matter) and the trade deficit or increased productivity.

But the opponents of technology or trade could argue that the failure to observe a negative correlation between jobs and technology or jobs and trade deficits is spurious. True, the number of jobs in America has grown while technology has gotten better and better. But if we hadn’t had technology we’d have even more jobs. So we have to control for the other factors that might have made jobs increase rather than decrease.

That’s very hard to do. I’d settle for hearing a list of the factors that might plausibly be offsetting the alleged effects of trade and technology. In the absence of that list, I’m pretty comfortable arguing that trade deficits and technology have little effect on the total number of jobs (rather than the number of jobs in particular industries). And the reason I feel that way is partly because of the total number of jobs rising but mainly, I suspect, because I have a belief about how the world works.

I use the word "belief" which might lead some to dismiss my views as simply a matter of ideology. But my faith in my view of how the world works has empirical support for its tenets. It’s not just a fantasy or a dogma or convenient. I just don’t have holistic empirical evidence on trade having no impact on the number of jobs.

My view of the world is that when we widen the ability of our fellow citizens and ourselves to trade with people other than just our own kind or nationality or religion or color, that that in turn allows trade to take place more productively. That in turn creates wealth, a higher standard of living. And that in turn creates new opportunities for employment that come along and replace the old.

This view of the world is supported by logic and lots of empirical evidence. But again, it’s not the empirical evidence of an overarching kind that let’s me evaluate one corner of increased specialization, say the overall impact of NAFTA.

When I told the reporter that the net job loss numbers of the EPI are meaningless because they miss many of the jobs that are created, he said, so tell me where to look for those new jobs. And again, I had to disappoint him. I said that I couldn’t tell him where to look.

Why?

Because when we trade more with each other and use our limited resources more effectively, two kinds of new opportunities get created. We take the wealth and resources that have been freed up by more efficient trade (or the same effect when productivity increases) and we use those extra resources to produce more of what we like and to get some new stuff we couldn’t have had before. And yes, we also get an expansion of export-related jobs.

But the export-related jobs can’t capture all the job gains from having a more effective use of our skills and time and energy that comes from trading more widely. Especially if you run a trade deficit. That means that a lot of the new jobs that are going to be created aren’t going to have anything to do with trade. Just like finding ways to make steel with fewer people and more machines leads to new jobs in the steel-machinery making business but in lots of other industries that you can’t identify, that come from people being able to spend less on steel and having more resources to spend on other things.

So I can’t tell the reporter where to look. He has to look everywhere. It doesn’t make for a very good feature story.

So I’m sorry I can’t be more helpful. But I do think economics has a lot to say in helping us understand the effects of increased trade. It just doesn’t come from the bottom line of an empirical study.

P.S. I am ignoring any bureaucratic complications that occur in a real-world trade agreement. I wish we would just eliminate our tariffs and quotas rather than do all the bureaucratic and legal compliance wrangling involved in NAFTA.

P.P.S. For a pictorial version of these ideas with the data alluded to in the discussion, go here [2].

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[1] Economic Policy Institute: http://www.epi.org/newsroom/releases/2008/02/nafta-rscott-20080229.pdf

[2] here: http://www.invisibleheart.com/Iheart/TradeDeficitJobs.pdf

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