By Jonathan B. Wight

It’s too bad that most teachers continue to ignore transactions costs. This is most obviously true when discussing the benefits and costs of liberalizing trade.

The gains to trade through comparative advantage are demonstrated assuming that resources easily and costlessly move from one industry to another. We wave our hands and claim that all will be well (and the world a richer place) after opening up to trade.

This is a story I love, but not in its pristine form. Transition costs from one point on the PPF curve to another are really, really high.  Economic justice requires that these costs be identified and debated when discussing trade liberalization.

If the U.S. has a comparative advantage in intellectual property products and not in manufacturing, then resources have to flow out of Detroit and into San Francisco or Austin or Boston.  When workers leave Michigan they leave behind sunk investments in schools, hospitals, roads, shopping malls, houses, and so on.  All these investments have to be rebuilt in the area of growth.  We are paying twice for sewers, electrical hook-ups, and so on. That’s a huge write-off of both public and private investments. We are also assuming that everyone laid off can retool their human capital and find a new job in the growth sector.

Adam Smith was more pragmatic. He worried about the transition costs and cautioned to head toward freer trade only slowly, so that these investments could be depreciated.

David Warsh points us toward a new paper by David H. Autor, David Dorn, and Gordon H. Hanson, “The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade.”  The article notes that the frictions to reach a new equilibrium are high—much higher than previously estimated:

"Adjustment in local labor markets is remarkably slow, with wages and labor-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock commences. Exposed workers experience greater job churning and reduced lifetime income. At the national level, employment has fallen in U.S. industries more exposed to import competition, as expected, but offsetting employment gains in other industries have yet to materialize. Better understanding when and where trade is costly, and how and why it may be beneficial, are key items on the research agenda for trade and labor economists."

It would not be the first time that economists came to common sense late in the game. Economists have pontificated for decades that trade deficits with China play only a small role in the decline of U.S. manufacturing. New estimates seem to suggest what blue collar middle-aged males (Trump and Bernie supporters?) have known for some time: the rise of China came at a much larger expense to the middle class than previously imagined.

Moreover, the decline of manufacturing came coincident with the rise of finance, and the two are related: U.S. current account surpluses were financed by foreign capital inflows to our financial markets, with the expected effects on income and wealth distribution. The rage grows.