Transport costs, fuel prices & trade

As fuel gets more expensive the transport costs associated with international trade get larger and trade diminishes. By how much? Paul Krugman cites a study (by Nuno Limão and Anthony J. Venables) that deals with transport costs and geography as factors determining trade. It implies that a doubling of fuel costs will contract trade by 45%. Current fuel price hikes if sustained would reduce trade by 17%.

Of course such significant reductions would reduce the demand for fuels and have the general equilibrium effect of reversing the price increases.

Much the same effects apply to reductions in the demand for long distance travel induced as a consequence of higher fuel costs.

It is certain that the direct initial effects of a fuel price increase will dominate offset effects that reduce fuel prices. This means that from the viewpoint of travel and trade the world is getting bigger.

Exporting health services: Bumrungrad

While I lived in Thailand in the 1980s I always appreciated the possibility of cheap local dental and health care. It was easy to find well-qualified, English-speaking dentists and doctors – an incidental bonus was that the nurses who looked after you were often extremely attractive. The cost of these services was a fraction (about ½ as I recall) of the cost of the services in Australia. It would be an even smaller fraction of the cost of services in the US.

One of the large hospitals I visited occasionally for check-ups was Bumrungrad on Soi Nana, Sukumwit Road in Bangkok. It is now Bumrungrad International Hospital and has a website advertising services to both locals and foreigners. In fact it instructs foreigners in every aspect of their planned visit to receive health services in Thailand.

Business Week now has a feature article on Bumrungrad. 65,000 Americans visited the hospital last year compared to about 10,000 in 2001. The hospital earned $41 million US in profits last year on revenues of $618 million US. 55% of the hospital’s revenues came from foreign patients.

Many of the US customers came from the pool of 47 million Americans without health insurance. Despite this Bumrungrad has signed an agreement with Blue Cross & Blue Shield of South Carolina, with the American insurer agreeing to cover expenses for members who travel from the U.S. to the Thai hospital.

Bumrungrad faces capacity constraints and will increase its capacity by 20% to 2012. Its rival Bangkok Dusit Medical Services is less capacity constrained and, although it doesn't get as many Americans, it attracts more international patients overall, with 649,000 checking in last year.

With low transport costs the range of developing country service exports will expand and will put a welcome cap on service costs in developed countries.

Meanwhile Gregory Mankiw looks at the lighter side of exporting childcare services.

Compensating the unemployed?

The NYT has a stern neoclassical defence of free trade (by Stephen Landsberg) with outsourcing. Landsberg is clearly discussing US-Chinese trade from the US viewpoint. The gist is that just as we should not feel morally obliged to compensate a restaurant owner when we shop for food at a cheaper McDonalds store so too the US should feel no obligation to compensate a worker when his job disappears because of outsourcing of work to China.

A couple of weeks ago I outlined the non-new thesis by Paul Krugman that significantly higher levels of US trade with low labour cost countries promotes inequality. I argued that education and compensatory tax transfer policies could address these issues while leaving the benefits from free trade intact.

Landsberg’s argument seems to confuse efficiency and equity issues. Both he (and Krugman & myself) believe price reductions from trade liberalisation do provide ‘gains-from-trade’ to the community as a whole but there is still an issue of inequality that most of us are concerned with addressing. As far as I can see there is no substantial intellectual case against free trade. But there is recognition that inequality will worsen as most manufactured goods in developed countries are produced in low wage countries and this needs to be addressed. Indeed it wouldn’t make much difference how the inequality was generated it would need to be addressed.

By the way twice in my life I have been in situations where job layoffs occurred. I saw the psychic misery and anxiety that was generated. I have also had friends and colleagues who unsuccessfully sought paid work for long-periods – one did charity work for a time because he felt so useless and despondent.

Since these events I have always been fairly hostile towards well-paid economists whose attitude to people losing their jobs is, ‘oh well, that’s life’. Landsberg’s ‘ho-hum’ attitude does not impress.

Freeing up international trade with poor countries & wage inequality

Paul Krugman in today’s NYT summarises a widely-held assessment of the impact of trade with low wage countries on US growth and inequality. There is nothing radical about his claim - free trade with poor countries increases growth but increases wage inequality by driving down unskilled wages.

The same general message applies to effects on Australian labour markets of promoting freer trade here with poor countries.

The US now imports more manufactured goods from poor than from other advanced economies so most industrial trade is with countries that pay their workers much lower wages. This reduces the real wages of many and he claims ‘perhaps most' workers in the US. Krugman's claim: Trade between countries at very different levels of economic development tends to create large classes of losers as well as winners.

Workers with less formal education either see their jobs shipped overseas or find their wages driven down as other workers with similar qualifications crowd into their industries and look for employment to replace the jobs they lost to foreign competition. And lower prices of goods that these unskilled workers purchase are not, in themselves, sufficient compensation.

Textbook economics says that free trade normally makes a country richer – growth prospects are in aggregate improved - but it doesn’t say that it’s normally good for everyone. Still, when the effects of third-world exports on U.S. wages first became an issue in the 1990s, a number of economists looked at the data and concluded that any negative effects on US wages were modest. These effects may no longer be as modest as they were, because imports of manufactured goods from the third world have grown dramatically — from 2.5% of G.D.P. in 1990 to 6% in 2006.

And the biggest growth in imports has come from countries with very low wages. The original “newly industrializing economies” exporting manufactured goods — South Korea, Taiwan, Hong Kong and Singapore — paid wages that were 25% of US levels in 1990. Since then, the sources of imports have shifted to Mexico, where wages are only 11% of the U.S. level, and China, where they’re only 3-4%.

There are some qualifications. Many made-in-China goods contain components made in Japan and other high-wage economies. Still, there’s little doubt that the pressure of globalization on American wages has increased.

Krugman sums up:

‘So am I arguing for protectionism? No. Those who think that globalization is always and everywhere a bad thing are wrong. On the contrary, keeping world markets relatively open is crucial to the hopes of billions of people.

But I am arguing for an end to the finger-wagging, the accusation either of not understanding economics or of kowtowing to special interests that tends to be the editorial response to politicians who express scepticism about the benefits of free-trade agreements.

It’s often claimed that limits on trade benefit only a small number of Americans, while hurting the vast majority. That’s still true of things like the import quota on sugar. But when it comes to manufactured goods, it’s at least arguable that the reverse is true. The highly educated workers who clearly benefit from growing trade with third-world economies are a minority, greatly outnumbered by those who probably lose.

As I said, I’m not a protectionist. For the sake of the world as a whole, I hope that we respond to the trouble with trade not by shutting trade down, but by doing things like strengthening the social safety net. But those who are worried about trade have a point, and deserve some respect’. (my bold)

Greg Mankiw points out that Krugman’s argument is totally a priori and begs for empirical evidence – the bolded passages need to be demonstrated though Krugman’s overall claims seems intuitive. To this point empirical evidence supports the direction of the effects suggested by Krugman but not their extent. Moreover, Krugman’s claim is supported by evidence of low US wage growth. But this evidence is also consistent with the high immigration policies of low-skilled labour that the US has pursued. Some econometrics is called for here to back up the claims. (My own preference for Australia is to do as it did under the Howard Government and emphasise high-skilled migration which does not harm the less skilled but creates better job opportunities for these low-paid workers).

It is also clear that theory predicts that returns to inputs other than unskilled labour (namely skilled labour and capital) must be increased more than the losses to unskilled labour. Thus incomes overall do rise with freer trade it is just that low income earners lose out. Overall the US economy must enjoy uncompensated gains from improved opportunities to trade with countries such as China provided that China pays for all of its inputs*.

There are two types of policies I believe can ensure free trade benefits all:

1. One policy approach is to effect transfers which bring about the requisite compensations. Taxes on capital and on high income skilled labour need to be increased not cut, if all sections of the community are to benefit from freer trade with the developed world. It is a lesson Australia needs to remember. This is a variant of Krugman's policy to 'strengthen the social safety net'.

2.. Another approach is to try to provide an increasingly skilled workforce. This is a more positive policy which recognises that having people doing unskilled, unpleasant work in poorer countries creates opportunities for people in wealthier countries to do more skilled, creative work and to enjoy their lives even more. This can only occur however if private individuals are motivated to invest more in their own skills and human capital. On the demand side this does not seem to be the pattern at present – kids in Asia (and Asian migrants to developed countries) seem to have a much higher motivation to acquire skills than residents. On the supply side Australians seem to want a cheap education system heavily dependent on full-fee income Asian students and that is what they are getting. This needs to change.

Adopting these sorts of policies will enable countries to fully enjoy the benefits of free trade while limiting the distributional damages. Not addressing distributional concerns will ultimatetely undermine the case for free trade.

*Paul Samuelson in the link points out that if China 'steals' technology by importing educational services at less than the value of such services that the US can be immiserised by trade – its per capita income can fall. But even in this case Samuelson still supports free trade on the grounds that the losses from restricting trade will be more than the losses from the theft-induced immiserisation.

E. coli conservatives

Paul Krugman blames Milton Friedman for promulgating the foolish libertarian precept that nothing should be regulated - not even the quality of the foods we eat. Why regulate food quality asked Friedman - firms will have sufficient incentives based on self-interest not to poison their customers.

That is generally a false claim - the incentives may be inadequate. Food providers may be ignorant rather than maliciously and myopically greedy.

Failure to regulate means that consumers are dependent on the quality protection services of foreign governments which might be asking quite a lot.

Some recent food imports into the US from China have made a lot of people very sick. The gains-from-trade in this case have taken the form of profits to the vendors and food poisoning of the unfortunate customers.

The Washington Post, reviewing F.D.A. documents, found that last month the
agency detained shipments from China that included dried apples treated with
carcinogenic chemicals and seafood “coated with putrefying bacteria.

The same has occurred recently with toothpaste and pet food exports from China, some of which ended up in Australia.

Of course there should be careful monitoring and regulation of the food trade.

We should also carefully monitor the views of libertarian fanatics who see the free operation of markets as the answer to everything. They are not. Information problems, ignorance, externalities and public good issues provide a host of reasons for intervening in real economies.

Conservative ideologues who advance arguments for minimal government are a deluded lot who have done much damage to contemporary America. They are catching on in Australia.

No future for Australian car assembly?

Peter Martin has a good article on troubles in the Australian car industry. I'll comment on a few points.

Australians have traditionally had a liking for large medium cars. This was the market segment where our manufacturers had a comparative advantage. We then imported small cars and exported, with for a time growing success, larger cars. I assume the local preference for large gas-guzzlers has fallen with the current, seemingly permanent, escalation in petrol prices.

Peter is accurate in criticising the enormously expensive and stupid set of production subsidies that continue to be given to the Australian car assembly industry. He mentions some recent handouts but the worst part of the protectionist system is ACIS, the Automobile Competitiveness and Investment Scheme, which is an expensive way of keeping Mitsubishi afloat. ACIS subsidises output not exports and, because the subsidies are subject to binding caps, amounts to a set of lump-sum handouts to foreign multinationals. The fallacious arguments for retaining low levels of tariff protection might offer some short-term palliative for the industry at the expense of local consumers but, increasingly, are an irrelevancy as cheap labour costs and economies of scale in emerging NICs swamp any possibility for the local industry to survive with anything less than towering levels of tariff support.

By the way in assessing performance of some players declared profits are poor guides. For example, one must also take with a grain of salt the published profit figures of firms such as Toyota given evident proclivities to transfer price. These moves transfer taxation liabilities offshore and provides local offshoots of international firms to bleat and threaten for further handouts from naïve State and Commonwealth Governments.

A decade ago the Button Plan looked like it might provide the Australian car assembly industry with a future. By concentrating output among a smaller number of producers and by reducing numbers of models it has certainly improved industry efficiencies and, if nothing else, delayed the industry’s local collapse. But increasingly I agree with Peter that the Australian industry probably does not have much of a future despite the concentration of relatively low-cost design skills here. In my view the shift in car design and assembly in the future will lead away from all traditional production venues to a heavy concentration in China which, by 2020, will might well be the biggest car market on earth. This is one forecast I would happy to be proved wrong about but I am pessimistic.

I generally liked Peter’s arguments though I choked a bit when I saw his support for Kevin Rudd’s plan to hand out $500 million to build a ‘green car’ locally. Why should government be involved in picking winners in this way? Where are the possible market failures here?

It frightens me that Rudd can promote populist industry policies of this type. Generally, the Labor Party’s populist ‘industry policies’ frighten me - I expect there will be more of the same in the future in a variety of manufacturing settings. Indeed as the election draws near there is the possibility of a protectionist bidding wear with the Coalition.