Not all free trade is created equal

Free trade generally comes down to an argument between growth vs. distribution. Few would argue that opening up a rich country's markets boosts its GDP (the evidence is much sketchier for developing countries). But that GDP boost may come with a price - increased inequality of income and wealth, as workers are forced out of their jobs and company owners reap ever greater profits. Whether we embrace free trade, economists tell us, depends on whether we care more about GDP or the welfare of the poor.

I've long suspected that this tradeoff only exists for a certain kind of free trade: namely, trade between rich and developing countries. When we opened our markets to China, for instance, our company owners were able to cut costs by offshoring manufacturing operations. Our manufacturing workers, though, found themselves either out of a job or facing wage cuts, as they were suddenly forced to compete with hundreds of millions of poor, low-wage Chinese labor that was abruptly dumped on the market. Capital became scarce, labor became plentiful, so profits went up and wages went down.

But I have always guessed that trade between rich countries and other rich countries - between us and Japan and Europe, for example - does not entail these tradeoffs. Japanese workers are already as well paid as American ones, and Japanese companies already have as much capital as ours. Hence, opening our market to Japan (and theirs to us) will only result in the countries being able to specialize in what they do best - the famous win-win result of classical trade theory. "Outsourcing" a job to Ireland or Korea, rather than a cost-cutting move that would push up US profits and push down US wages, would simply result in Ireland or South Korea "outsourcing" a job to the U.S. in return - and everyone's wages and profits would get a boost.

Now there is evidence to support my guesses:

We also examine the impact of increased offshoring by US multinational firms on wages of workers in the US. We find that when US companies increase their offshoring activities to low-income countries, this hurts US wages, but that more offshoring to high-income countries is associated with an increase in US wages...

Policies (such as those proposed by the Obama administration) designed to curb the negative effects of offshoring on US jobs need to distinguish between offshoring to rich and poor countries. Since the negative effects are restricted to low income destinations, any policies which discourage offshoring in high-income regions (such as Ireland or France) will have the unintended effect of hurting the very workers they are designed to protect.

So, basically, we should maximize free trade with rich countries, but be very careful about our approach with poor countries (especially China).