FREE TRADE AND THE IMAGINARY WORLDS OF ECONOMIC MODELERS
PCDForum Column #45, Release date April 5, 1993
by James Stanford
Many labor representatives in the United States and Canada fear that a North American Free Trade Agreement (NAFTA) will lead to a redirection of investment toward low-wage regions of the continent, consequently reducing wages and employment opportunities in higher-wage areas. Yet free trade advocates regularly cite projections claiming that the agreement will create thousands of new jobs and benefit workers in all participating countries. Free trade economists dismiss the critics as economically illiterate or special interest protectionists. The free trade advocates usually avoid mentioning that the projections they cite are produced by computer simulations known as computable general equilibrium (CGE) models based on assumptions that bear little relationship to reality.
Consider an imaginary conversation between an auto worker in the Midwestern United States and the architect of a CGE model. The worker expresses her fear that:
If NAFTA goes through Ford will surely move its Taurus plant to Mexico where it can hire workers for a tenth of my pay with no independent union and export cars back to the United States. With the labor market already depressed in this part of the country I don't see any prospect of finding a job at comparable pay.
The CGE modeler quickly reassures the employee.
Don't worry, I've constructed a computer simulation that demonstrates you will actually benefit from the trade agreement. Here's how it works. In my model I assume capital is immobile. Therefore Ford cannot move its plant to Mexico. Nor would it want to, because I assume unit labor costs are the same in both countries and in my model Americans have a clear preference for U.S. made products, even if they are more expensive.
My model also assumes full employment and specifies that anything imported to the U.S. from Mexico must be balanced by American exports, so new export industries will necessarily spring up here to replace any industries that might be displaced by Mexican imports. Since you earn above-average wages at Ford, you obviously possess valuable skills. With full employment you will certainly find another job very shortly in one of these new export industries, probably with higher pay than your current job. So NAFTA will be great for you.
The discussion is hypothetical. However, as unreal as the assumptions cited by the modeler may seem, nine of ten CGE NAFTA models I recently examined included at least one of them. Two of the models included all of the assumptions. While we might be impressed by the rigor with which the modeler in the dialogue has identified the conditions under which NAFTA or other free trade agreements might prove beneficial to the Ford employee, we might also forgive the worker with real world knowledge for rejecting the free trade arguments of an economist who proposes to cross a deep ravine by assuming there is a bridge.
Indeed, I found that the more realistic the assumptions of the simulation model, the more likely it is to show that the prospective NAFTA agreement will produce negligible or negative economic consequences for at least one of the partners. Real world experience goes further in suggesting that the consequences of NAFTA will be far more negative, particularly for the U.S. and Canada, than projected by the most pessimistic of these models. Even though Canada and the United States have relatively similar economies, the existing Canadian-U.S. free trade has seriously damaged Canada's economy as factories relocated to lower cost regions in the United States, increasing unemployment in Canada and placing downward pressure on Canadian wages. Given the much lower unit labor costs in Mexico, skeptical workers who intuitively sense the gap between the economists' theoretical models and the real world should not be dismissed as special interest protectionists. Continental integration holds the possibility, not the guarantee, of mutual benefit, but only if accompanied by coordinated continent-wide measures to ensure balanced trade, strong demand, the recognition and protection of labor rights and other standards, and the genuine sharing of the gains from trade.
Ironically, labor would likely support a NAFTA enthusiastically if the agreement guaranteed the same conditions assumed in CGE models. The modelers' assumption of such conditions is somehow acceptable to free trade advocates. Yet labor's call for real-world measures to promote these conditions is brushed aside as raising the specter of managed trade. A willingness by model builders and trade negotiators to confront issues like investment diversion and unemployment would be an important step toward lessening resistance to trade reform.
James Stanford is a doctoral candidate in economics at the Graduate Faculty of the New School for Social Research and a research fellow at the Brookings Institution, 1775 Massachusetts Avenue, N.W., Washington, D.C. 20036-2188. The column is prepared and distributed by the People-Centered Development Forum based on his article "Continental Economic Integration: Modeling the Impact on Labor," Annals of the American Academy of Political & Social Science, 526, March 1993.