David R. Henderson  

Kleiman on Trade and Taxes

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So when the modern Republican Party (R.I.P), in the name of "small government" and opposition to "class warfare," set its face against policies to redistribute the gains from economic growth, it destroyed the theoretical basis for thinking that a rising tide would lift all the boats, rather than lifting the yachts and swamping the trawlers. Free trade without redistribution (especially the corrupt version of "free trade" with corporate rent-seeking written into it) is basically class warfare waged downwards.
This is from drug policy expert Mark Kleiman's recent post, "Trade, Trump, and Downward Class Warfare." His piece is not long and so if you want to completely follow my critique, you might want to read it.

The paragraph I quoted above gives the gist of his argument. He leads with this:

In a nutshell: opponents of taxing the rich have destroyed, on a practical level, the theoretical basis for believing that free trade benefits everyone.

Do you see the problem? Kleiman doesn't and Brad DeLong doesn't. I do.

Kleiman's argument shows that by "the rich" he means high-income people, not wealthy people. His discussion is about incomes.

There are two problems with Kleiman's argument.

First, on taxes. Opponents of taxing the rich have been singularly unsuccessful. Under both Obamacare and the tax deal negotiated between Vice-President Biden and Senate Majority Leader Mitch McConnell, the marginal tax rate on income for high-income people shot up in the last few years. Under Obamacare, the Medicare tax rate on high-income people was raised from 2.9% to 3.8%. Under the Biden/McConnell tax deal, the top marginal tax rate rose from 35% to 39.6%. As a result, high-income people are paying a much higher percent of their income in taxes than lower-income people.

This isn't exactly a secret. Check any public finance text and you'll likely find a table that gives the percent of income paid in taxes for various income levels. Or check this report from the Congressional Budget Office, dated November 2014, after the tax increases were in place.

According to the CBO report, the top 1% paid an average of 33% of their income in taxes, up from 29% before the Biden/McConnell deal, and the lowest quintile paid an average of 3% (up from 2%). The people in 81st to 99th percentile paid an average of 22%, up from 21%. The people in the middle 3 quintiles paid an average of 13%, up from 12%.

In short, Kleiman's idea that opponents of taxing the rich have succeeded is a fantasy.

That's what I'm sure of.

The second problem with Kleiman's argument is one that I'm only 90% sure of: who gains from trade.

Kleiman feels confident that international trade benefits only the rich, and, I remind you, by "the rich" he means high-income people. He writes:

But the bottom line is that all of the gains, not merely from trade but from economic growth, have been concentrated in the hands of a relative few.

I'm pretty sure he's wrong. I think of clothing, in which we have had a major increase in free trade in the last few years. Almost everyone in America buys clothing. Another item is oil. There has not been a major increase in free trade on the import side: we already have it. But oil is traded internationally and its price has fallen like a rock. Almost everyone buys oil, either directly or embodied in a product such as gasoline or transportation of consumer items.

Kleiman is making the classic mistake that Frederic Bastiat warned about over 160 years ago: looking at "what's seen" and ignoring "the unseen that must be seen." He is probably looking at job losses for relatively low-income people who lost their jobs because of free trade and often went to other jobs that paid less. There could be a few million people in this category and they have lost. But he's leaving out the tens of millions of low-income Americans who did not lose their job to free trade and are benefiting from buying the cheaper internationally traded items.

To his credit, though, Kleiman reminds us of the biggest gainers from trade with China, writing:

It also ignores the biggest gainers from trade: workers in low-wage countries, most notably the Chinese factory workers whose parents were barefoot peasants.


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COMMENTS (27 to date)
Brandon Berg writes:

Top rates on dividends and long-term capital gains also increased from 15% to 22-point-something.

In an ideal world this wouldn't need to be said, but this ostensibly lower rate doesn't mean that investment is taxed more lightly than labor; due to double taxation from corporate income taxes and the effects of taxation on compounding, among other things, investment income is actually taxed quite a bit more heavily than labor income.

foosion writes:

Lower income people do benefit from cheaper goods from trade, but they are hurt by the increased competition from others whose jobs are displaced by trade. In other words, they get cheaper goods but lower wages.

Modern trade policy tends to skew the distribution of income upwards. Lower income people are placed in competition with foreigners, many higher income types are protected (for example, we don't allow foreigners to compete with doctors and lawyers) and corporate owners and officers benefit from things such as increased intellectual property protection (a form of protectionism that redistributes many billions).

Trade may benefit Chinese peasants, but many in the US are more concerned with their fellow citizens.

foosion writes:

Regarding taxes, some rates are higher than in the recent past, but much lower than in many post-WWII periods. The economy did quite well in many of those periods.

ThomasH writes:

Henderson is correct that Kleinman does not make a rigorous case that the benefits of increased trade resulting from reduction in trade barriers in the last x years have on balance benefited high income people more than low income people as many people assume. And Kleinman is probably incorrect to single out taxes as the only way that losers from increased trade (or technological change) can be compensated distributed. But Henderson seems to miss the point that the political argument for measures to increase trade are based on the benefits being shared widely. If people doubt this, they will oppose freer trade.

Ironically, Henderson advances the same argument for the effects of freer trade on low income workers (with no more support than Kleinman gives for his position) as that of supporters of minimum wages: some few may become unemployed, but the vast majority will see higher real incomes.

mico writes:

The argument is just propaganda. If the theoretical basis for believing free trade benefits all rested on the assumption that trade restrictions would exist redistributing its benefits then there never was a theoretical basis for the belief that free trade benefits all. That might be true but isn't the argument he's making.

David R. Henderson writes:

@ThomasH,
Ironically, Henderson advances the same argument for the effects of freer trade on low income workers (with no more support than Kleinman gives for his position) as that of supporters of minimum wages: some few may become unemployed, but the vast majority will see higher real incomes.
Our senses of irony must be different. Trade, as Kleiman admits, produces benefits in excess of costs. An increase in the minimum wage produces costs in excess of benefits.

JK Brown writes:
...it destroyed the theoretical basis for thinking that a rising tide would lift all the boats, rather than lifting the yachts and swamping the trawlers.

A rising tide does lift all boats, yacht and trawler alike. Of course, if those boats are moored, things can get a little dicey if you aren't tending the lines or anchor chain. And if they are silted in from years of drawn up in the shallows, they can swamp before the water lifts the hull or coming of the mud can expose a breach in the hull. And eventually all boats rising on a tide will reach the end of their chain and go adrift as the anchor lifts off the bottom. Or if if hard and fast due to a fouled anchor or hard mooring, something will giveway and cast a now damaged boat adrift. And if no one takes command, fires up the engines, hoists the anchor from underfoot or cut free the dragging mooring, then disaster is at hand for there be rocks and shoals and shores about one which to founder or rising swells in which to breach.

Now your high-income yacht is likely to have more chain to let out and a more attentive watch to tend the lines and get underway to safer havens. The trawler will have limits on the amount of chain they carry to optimize their fish hold capacity and a more lackadaisical crew who earn a share when fishing but are biding time in harbor. The small boat be on a short stay or hard mooring and perhaps silted in from disuse and thus be at risk to a rising tide due to lack of adaptation.

In short, a rising tide lifts all boats, but those boats need to have an attentive watch and be ready to get underway to deal with the changing conditions lest the tide cast them adrift and upon the lee shore.

Charlie writes:

DH,

Kleiman says: "But the bottom line is that all of the gains, not merely from trade but from economic growth, have been concentrated in the hands of a relative few."

Figure 8 of the CBO report that you link to attests to this point. Since 1979, the top 1% has seen income gains of 174%, the rest of the top quintile gains of 56% and the other 80% of households saw cumulative gains of 16% over the 33 years.

Kleinman's thesis is that if most people aren't benefiting very much from trade and economic growth, why should they care about it? By not adjusting to the change of who GDP growth is accruing to, Republicans undermine broad support of free trade (home and abroad).

You respond:

1. First, by pointing to tax increases that Republicans were against, that makes absolutely no sense.

2. With a conjecture not supported by the very evidence that you link. I mean, if your whole point was that Kleiman should have said "almost all the gains" instead of all. Fine, I concede. Income growth of 16% in 33 years amounts to an annual growth rate of 0.45%, which is greater than zero. But otherwise it looks like you simply failed to grasp or deliberately skirted Kleiman's main thesis.

Don Boudreaux writes:

David Henderson's response, here in the comments section, to ThomasH is correct and germane. But at least three additional points deserve to be mentioned (in no particular order):

(1) The unemployment caused by a minimum wage is permanent, in the sense that even in theory it will always exist. Unlike the unemployment that arises when trade becomes freer, the unemployment that is caused by minimum-wage legislation is not the result of transaction costs and other frictions that prevent workers who lose their jobs from finding alternative employment immediately. Put differently, in principle if not in practice, no workers need be rendered even temporarily unemployed by freer trade; in contrast, the minimum wage necessarily (in the absence of genuine monopsony power) causes some workers to lose their jobs and causes these destroyed jobs to remain destroyed.

Put in yet another different way, unlike with free trade, the creation of unemployment is not a temporary or incidental consequence of minimum-wage legislation. Lasting job destruction is part of the essential logic of the minimum wage. While in principle, and over time also in practice, free trade does not lead to permanent job losses, job losses caused by the minimum wage, in addition to springing from the very logic of the minimum wage, are indeed permanent.

Second, unemployment caused by free trade is, in reality, simply a particular instance of unemployment caused by changes in the pattern of economic activities. In principle it differs not a whit from the unemployment caused by, say, consumers coming to prefer more chicken to beef, more outdoor recreation to indoor entertainment, or more wine to whiskey. That is, the unemployment caused by freer trade is inseparable from the very logic of a market economy driven by consumer sovereignty and competition. Far from free trade being an exception to the rules of a market economy, it is protectionism that is an exception. The minimum wage, in contrast to free trade, is emphatically not part of the logic of a market economy; like protectionism, the minimum wage is a suspension of, or an interference with, the logic and principles of a market economy. If this fact means nothing else, it means that free trade (like any competition-driven change in the pattern of consumer spending) enjoys a presumption of legitimacy while the minimum wage, which is a restriction on the operation of the market and on voluntary contracting, operates under a presumption of illegitimacy.

Third, economic theory and empirical evidence strongly suggest that the ill consequences of the minimum wage are not randomly distributed. These ill consequences are suffered only by low-skilled workers and, even among low-skilled workers, disproportionately by those who are the least advantaged (for example, by inner-city blacks rather than by suburban whites). The downsides of free trade, in contrast - and in addition to being only temporary and part of the larger logic of the real-world market - are much more random. These ill consequences are not more likely to fall only on low-skilled workers, or on blacks rather than whites.

ThomasH writes:

David,

Perhaps I misunderstood your argument. I thought you were saying that although trade might cost some employment by relatively low income people, many other low income benefitted from higher real incomes. That argument did not depend on whether the total benefits are positive as with trade or negative as with the MW.

David R. Henderson writes:

@Charlie,
First, by pointing to tax increases that Republicans were against, that makes absolutely no sense.
Yes, it does. Remember the context. For Kleiman’s argument to make sense, it has to be the case that high-income people don’t pay much of their income in taxes and that the taxes on high-income people have not increased. The numbers show that neither is the case.
Figure 8 of the CBO report that you link to attests to this point. Since 1979, the top 1% has seen income gains of 174%, the rest of the top quintile gains of 56% and the other 80% of households saw cumulative gains of 16% over the 33 years.
Two problems with that. First, it understates real income growth at all levels because the CPI overstates inflation substantially and, cumulatively over that time, by over 30%. Second, households are smaller now than in 1979 and so per capita income is substantially higher.

Kenneth A. Regas writes:

Dr. Henderson,

Glad to hear you have doubts about the distribution of benefits from free trade. The losers these days are low-IQ workers. When the work product of poor foreigners floods into our country, such as in form of apparel, the low-IQ workers who would have done the sewing do not have a rich set of alternatives. They can't be trained for the work that opens up in, say, airplane manufacturing. This is Econ 101 + Ricardo. The low-IQ workers who had previously benefited from their relatively small numbers relative to the high-IQ crowd, now find themselves with many more competitors in their sector, reducing the market value of their labor.

And no, the fact that some goods - the very ones they formerly made - are now cheaper is no bargain for them. The math is easy. Suppose that low-IQ workers provide 10% of the country's market basket of goods and services, and that foreign trade lowers the value of these by 20%. The wages of those workers goes down by ~20% while their cost of living goes down by ~10% of ~20% = ~2%. (Obviously I'm not arguing for these numbers, but for logic that would work with any reasonable set of such numbers.)

Prof. Boudreaux is correct that if restriction of some trade across international borders - say in the form of tariffs on shoes and shirts - is illegitimate because it's anti-economic, arbitrary, and an offense against human freedom (help me here, Prof. Boudreaux if I left something out) then maybe the low-IQ workers must accept their fate, because their standard of living absolutely depends on all the other trade, foreign and domestic, that makes our modern economy possible.

But boy, that sure is a big if.

Ken

pyroseed13 writes:

Doesn't Kleinman sort of have a point? If people at the lower end of the income distribution do not believe they are benefiting from trade with low wage countries, and you could make a good argument for this based on Autor et al., then their support for trade weakens.

I would phrase his argument different however. I don't think much of trade with China for instance has contributed to inequality between the 1% and everyone else. But I do think it has contributed to some inequality between low income and middle income households. If that is case, then it seems that without some compensation aka distribution for those low income households, then it will become for different to advance support for free trade.

Now compensation also carries its own set of tradeoffs. If it requires raising distortionary taxes, then it may not prove beneficial at all. In short, I do have any good answers to this problem, and I do not think that protectionism is the solution either. But to pretend as if this problem does not exist strikes me as elitist to its core. It's not certainly not going to help the reputation of economists.

To Don's point, I agree to some extent that trade with China is probably not significantly different than if I choose buy Coke over Pepsi. If am I obligated to compensate the workers at Pepsi? No, but at this same time, this argument misses an important distinction. We do not live in a world where "free trade" is the default policy. We negotiate trade among countries through the WTO. This means that reducing tariffs and transitioning to more trade really does impose substantial costs on a subset of workers. Again, I'm saying that protectionist policies would be better,. I'm merely stating the economists are ignoring some of the costs of trade with low wage countries at their peril.

Charlie writes:

"Yes, it does. Remember the context. For Kleiman’s argument to make sense, it has to be the case that high-income people don’t pay much of their income in taxes and that the taxes on high-income people have not increased."

No the thesis is that Republicans have destroyed the argument for free trade by opposing the redistribution of trade gains, even if those gains accrue only to the top. He argues that's their clear agenda. Whether in practice they've entirely succeeded is another matter, there is this whole other party after all...

"Two problems with that...CPI overstates inflation substantially and, cumulatively over that time, by over 30%."

The CPI calculation effects both top and bottom groups.

"Second, households are smaller now than in 1979 and so per capita income is substantially higher"

This effect is infinitesimal when comparing the 1% to the next 19% and probable the next two quintiles after.

Pajser writes:

It is easy to imagine two opposite, improbable but theoretically possible extreme cases. In the worst case (for Americans) all Americans (even those working in the local services) are out-competed and have to accept the same wages (and prices) as Chinese have. In the best case, all Americans already work or easily transition to areas Chinese do not out-compete and they get cheaper goods, without income loss. The reality must be somewhere in between the best and the worst case, but it is impossible to deduce where it is without data.

David R. Henderson writes:

@Kenneth A. Regas,
And no, the fact that some goods - the very ones they formerly made - are now cheaper is no bargain for them. The math is easy. Suppose that low-IQ workers provide 10% of the country's market basket of goods and services, and that foreign trade lowers the value of these by 20%. The wages of those workers goes down by ~20% while their cost of living goes down by ~10% of ~20% = ~2%. (Obviously I'm not arguing for these numbers, but for logic that would work with any reasonable set of such numbers.)
Right. With your numbers, your point follows.
What I said in my piece above is that I’m pretty sure it’s more like a few million low-income people are worse off and tens of millions of low-income people are better off. What you have done is just single out the low-income people who are worse off and leave out the much greater number who are better off.

David R. Henderson writes:

@Charlie,
We read Kleiman differently. He was attempting to explain the Trump phenomenon. For all these people to be so disaffected, it has to be, in his view, that that’s because the Republicans have made sure that the gains from trade go only to one group. For that to be true, according to his reasoning, it has to be the case that they have stymied tax increases on high-income people.
The CPI calculation [a]ffects both top and bottom groups.
Sure it does. My argument was never about the comparative gains to various income groups: it’s that lower-income groups are gaining a lot.

Effem writes:

Part of the problem is that we can't observe people's utility functions. We seem to (maybe) agree that trade helps the "bottom" but helps the "top" a lot more.

I, for one, would take a slightly lower absolute gain to better keep pace on a relative basis. Knowing you are falling behind and being subject to the constant displays of intellectual arrogance from the "winners" has sizeable negative utility.

Others may disagree - But in aggregate we can't know. The best (although inefficient) display we have of collective utility preferences are elections. I will take the Trump+Sanders phenomenon to indicate that relative status matters a lot more to ordinary people than economists assume.

David R. Henderson writes:

@Effem,
I don’t know what “collective utility preferences” are. I suspect that they don’t exist.
In any case, elections are one of the worst ways to know what people’s values are. Most realize that their individual votes don’t matter, and therefore they tend not to get information about the candidates’ views. Also they are voting for a package deal. Read this item from the Encyclopedia for more.

Kenneth A. Regas writes:

@David Henderson,
I should think that within IQ sectors, labor is pretty fungible, particularly at the low end, preventing the segregation of the losses to particular members of any such sector. The former apparel makers flood the elder care industry, lowering wages in a field that is less tradable than apparel. So free trade in apparel and similar goods ultimately acts IQ-class-wise, not industry-wise, on wages. And people with IQ's below, say, 85 are a huge class. No?
Ken

Effem writes:

@David
I understand the limitations of elections but I don't know of a better way. I might prefer a parliamentary systems but that has the same basic issues. How do you suggest we align society with individual utility functions?

Economists (along with the existing power structure) would like to think that something like "maximize per-capita wealth with little regard for distribution" is the most sensible utility function and it should be imposed on the system.

I, on the other hand, believe that every person should be entitled to express a preference for their own preferred utility system via elections. And if in that process we find out that preferences are different than we expected, that's an opportunity to better align the system with preferences.

I believe people are smarter than you give credit for. Most Sanders/Trump supporters that I know acknowledge that they are better off than 15 years ago. But they also believe they have fallen behind in what has become a two-tiered society. Further, they believe different "rules" apply to different tiers, leaving the system feeling inherently unjust. They express a strong desire to flatten the tiers and restore "fairness." And, yes, they realize it may come at the cost of some overall wealth.

This has become a large portion of our population and I believe economists (and others) would be wise to pay attention. The message coming from the population is quite firm.

Kenneth A. Regas writes:

@David Henderson,
Let's do some more numbers. At least 15% of Americans have IQ below 85. Let's say they produce fraction p of the country's market basket and that free trade with poor countries* reduces wages in their sector by fraction w (and other sectors not at all). You can pick your numbers for p and w. So then their sector sees about a 1-(1-w)/(1-pw) hit to their standard of living. You're saying there are reasonable values of p and w that don't have 15% of the workforce taking a meaningful hit to their standard of living?

Ken

* as opposed to a mercantilist policy that disfavors imports of apparel and similar goods

LD Bottorff writes:

After reading all of Kleinman's post once and parts of it twice, I still come away with the understanding that if you aren't taxing the wealthy at the rate that he prefers, you are engaging in class warfare against the poor. This talk of warfare frustrates me. I really wish we could stop using fighting words in describing our economic relationships. I wish, I wish, but the language of warfare seems to work well for Klein, Trump, Sanders, and so many others.

Mark writes:

Effem: "I, for one, would take a slightly lower absolute gain to better keep pace on a relative basis."
The interesting thing is, this seems like a mentality that could only make sense in the first world. In a truly poor country, the prospect of being able to by cheap goods like food from neighboring countries, thereby enabling survival, would far outweigh whatever negative utility they get from knowing that the rich people of their country will get even richer. Especially when talking about trade, in wealthy coutnries, that seems to be what it comes down to: not how well off I am, but my financial self-esteem based on how wealthy I am compared to others.

In so far as we're measuring actual material well-being, I think free trade definitely benefits the poor; arguably more than the rich. If free trade makes a cheap good necessary for survival affordable for millions of people, and also makes a few thousand rich people able to afford foreign exotic cars, even if the sum of the market value of the rich people's benefits outweighs the poor people's, per the law of decreasing marginal utility, the poor people actually get more utility from it.

The "inequality" argument really just seems to come down to wanting to keep a graph a little less skewed, perhaps to the benefit of some people's self-esteem, regardless of real material standard of living for actual poor people, the net effect on whom free trade is, I'd say, decidedly positive.

"This has become a large portion of our population and I believe economists (and others) would be wise to pay attention. The message coming from the population is quite firm."
Firm as it is, it's wrong. Crowds are not renowned for their foresight. Personally, I'd have no issue with the mass of the American population subjecting themselves to self-destructive policies for whatever emotional reason, if they didn't also mean to subject me to them as well.

khodge writes:

Kleiman performs a rhetorical mixed metaphor and his argument fails on that confusion. Even within these comments there has been a misstatement of his argument.

According to Kleiman, the problem is education: the better educated are able to directly profit from free trade (ignoring Bastiat's unseen), not high IQ, not wealth, not connections, not income. There is plenty of evidence that education correlates with wealth, success,&c. His argument is that the educated benefit from free trade.

Aaron McNay writes:

@Charlie and @David Henderson,
You both mention the CPI and its measurement errors for looking at income growth. However, it also looks like that changes in various prices also have different impacts on households at different income levels.

For example, Broda and Romalis (2009) find that when you look at the goods purchased by households at different income levels, the goods purchased predominately by low-income households had their prices increase at a lower rate than other goods.

This means that using economy wide inflation estimates understate real income growth by low-income households and overstate them for high-income households.

In fact, they find that most of these price changes were occurring in goods predominately purchased from China. This means that trade with China may be benefiting low-income households, we just are not measuring it.

Here is a copy of the paper I referenced:
http://www.johnromalis.com/wp-content/uploads/2012/07/Draft_v7.pdf

David R. Henderson writes:

@Aaron McNay,
I have a vague memory that I read this draft when it came out some years ago, but I’m not sure.
In any case, this is quite germane to the discussion. I thank you very much.

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