Friday, March 26, 2004

Support and Opposition to Free Trade 

This topic is getting a lot of play in the blogosphere right now. Matthew Yglesias has posted a call for ideas to address what he sees as growing support for protectionism in the US. Kevin Drum has speculated that popular opposition to free trade is inevitable because of what behavioral economists call "prospect theory" (the tendency to weigh possible losses more heavily than possible gains when making decisions about uncertain future events). Drum also comes to the (definitely correct) conclusion that:
The simple answer is that we need a better economy that's generating more jobs or else the country's emotional energy is going to be fundamentally opposed to free trade.

But Drum's use of prospect theory is a bit suspect. First, he suggests that what prospect theory says is that people who lose their jobs will be much more intensely unhappy than people who get new jobs will be pleased. While this is quite likely true, it isn't prospect theory, which has more to do with approaches toward risk than to what's already happened.

One could certainly use prospect theory to analyze individuals' feelings about trade agreements and the like (and the findings I discuss below certainly seem to match prospect theory's predictions), but it turns out that traditional economic theory (which just ignores prospect theory's implications) does a really good job of explaining this very subject.

If you're interested, there's a great book that came out a couple of years ago which uses survey data to examine who in the US opposes free trade (here's a brief synopsis, if you're not up for that much reading). It turns out that people who economic theory predicts will be hurt by trade (low-skill workers, in the US case) are exactly the same people who are most likely to oppose further trade liberalization.

The book also directly addresses Matthew Yglesias's concerns with a policy prescription: improve adjustment and insurance policies, which make losing a job much less painful, and you'll reduce protectionist sentiment. Sounds like a good idea to me.

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