Chapter 12
Controversies in Trade Policy
■ Chapter Organization
Sophisticated Arguments for Activist Trade Policy.
Technology and Externalities.
Imperfect Competition and Strategic Trade Policy.
Box: A Warning from Intel’s Founder.
Case Study: When the Chips Were Up.
Globalization and Low-Wage Labor.
The Anti-Globalization Movement.
Trade and Wages Revisited.
Labor Standards and Trade Negotiations.
Environmental and Cultural Issues.
The WTO and National Independence.
Case Study: A Tragedy in Bangladesh.
Globalization and the Environment.
Globalization, Growth, and Pollution.
The Problem of “Pollution Havens.”
The Carbon Tariff Dispute.
Trade Shocks and their Impact on Communities.
Summary
74 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Eleventh Edition
■ Chapter Overview
Although the text has shown why, in general, free trade is a good policy, this chapter considers two
controversies in trade policy that challenge free trade. The first regards strategic trade policy. Proponents
of activist government trade intervention argue that certain industries are desirable and may be
underfunded by markets or dominated by imperfect competition and warrant some government
intervention. The second controversy regards the recent debate over the effects of globalization on
workers, the environment, and sovereignty. While the anti-globalization arguments often lack sound
structure, their visceral nature demonstrates that the spread of trade is extremely troubling to some groups.
As seen in the previous chapters, activist trade policy may be justified if there are market failures. One
important type of market failure involves externalities present in high-technology industries due to their
knowledge creation. Existence of externalities associated with research and development and high
technology make the private return to investing in these activities less than their social return. This means
that the private sector will tend to invest less in high-technology sectors than is socially optimal. Although
there may be some case for intervention, the difficulties in targeting the correct industry and understanding
the quantitative size of the externality make effective intervention complicated. To address this market
failure of insufficient knowledge creation, the first best policy may be to directly support research and
development in all industries. Still, although it is a judgment call, the technology spillover case for
industrial policy probably has better footing in solid economics than any other argument.
Another set of market failures arises when imperfect competition exists. Strategic trade policy by a
government can work to deter investment and production by foreign firms and raise the profits of domestic
firms. An example is provided in the text that illustrates the case where the increase in profits following
the imposition of a subsidy can actually exceed the cost of a subsidy to an imperfectly competitive
industry if domestic firms can capture profits from foreign firms. Although this is a valid theoretical
argument for strategic policy, it is nonetheless open to criticism in choosing the industries that should be
subsidized and the levels of subsidies to these industries. These criticisms are associated with the practical
aspects of insufficient information and the threat of foreign retaliation. The case study on the attempts to
promote the semiconductor chips industry shows that neither excess returns nor knowledge spillovers
necessarily materialize even in industries that seem perfect for activist trade policy.
The next section of the chapter examines the anti-globalization movement. In particular, it examines the
concerns over low wages in poor countries. Standard analysis suggests that trade should help poor
countries and, in particular, help the abundant factor (labor) in those countries. Protests in Seattle, which
Chapter 12 Controversies in Trade Policy 75
shut down WTO negotiations, and subsequent demonstrations at other meetings showed, though, that
protestors either did not understand or did not agree with this analysis.
The concern over low wages in poor countries is a revision of arguments in Chapter 2. Analysis in the
current chapter shows again that trade should help the purchasing power of all workers and that if anyone
is hurt, it is the workers in labor-scarce countries. The low wages in export sectors of poor countries are
higher than they would be without the export-oriented manufacturing, and although the situation of these
workers may be more visible than before, that does not make it worse. Practically, the policy issue is
whether or not labor standards should be part of trade pacts. Although such standards may act in ways
similar to a domestic minimum wage, developing countries fear that such standards would be used as a
protectionist tool. A case study on the 2013 collapse of a garment factory in Bangladesh highlights this
tension. The Bangladeshi garment industry would not be globally competitive if it had to raise labor
standards to rich country standards. Bangladeshi garment workers, though very poorly paid by rich
country standards, earn more than workers in non-export sectors. A potential solution would be for
consumers in rich countries to pay more for goods certified to have been produced under improved labor
standards, thereby giving producers in poor countries both the means and the incentive to improve labor
standards,
Anti-globalization protestors were by no means united in their cause. There were also strong concerns that
export manufacturing in developing countries was bad for the environment. Again, the issue is whether
these concerns should be addressed by tying environmental standards into trade negotiations, and the open
question is whether this can be done without destroying the export industries in developing countries.
Globalization raises questions of cultural independence and national sovereignty. Specifically, many
countries are disturbed by the WTO’s ability to overturn laws that do not seem to be trade restrictions but
which nonetheless have trade impacts. This point highlights the difficulty of advancing trade liberalization
when the clear impediments to trade—tariffs or quotas—have been removed, yet national policies
regarding industry promotion or labor and environmental standards still need to be reformed.
This chapter also examines the link between trade and the environment. In general, production and
consumption can cause environmental damage. Yet, as a country’s GDP per capita grows, the
environmental damage done first grows and then eventually declines as the country gets rich enough to
begin to protect the environment. As trade has lifted incomes of some countries, it may have been bad for
the environment—but largely by making poor countries richer, an otherwise good thing. In theory, there
could be a concern about “pollution havens,” that is countries with low environmental standards that
76 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Eleventh Edition
attract “dirty” industries. There is relatively little evidence of this phenomenon thus far. Furthermore, the
pollution in these locations tends to be localized and is therefore better left to national rather than
international policy. An example of pollution that crosses borders is greenhouse gases, and this chapter
discusses the cap and trade system currently being debated in the U.S. Congress. Part of this policy aimed
at reducing carbon emissions is an imposition of a “carbon tariff” on imports from countries that do not
have their own carbon taxes. Proponents argue that such tariffs are necessary to prevent production from
shifting to pollution havens and to reduce the overall level of carbon emissions, while opponents argue that
these tariffs are simply more protectionism masquerading as environmental regulation.
The chapter concludes with a discussion of a new study that examines the effects of the rapid growth in
Chinese exports to the United States since 1991. Though the benefits of trade have likely been larger than
the costs, these costs have been concentrated within specific industries and within certain communities.
Industries tend to be geographically concentrated (taking advantage of external economies of scale), so
when an industry collapses due to trade, the losses are heavily concentrated within certain communities.
These losses have been magnified by a reluctance of U.S. workers to move away from economically
depressed regions. These concentrated losses from trade may help to explain the recent success of
protectionist political movements.
■ Answers to Textbook Problems
1. The main disadvantage is that strategic trade policy can lead to both “rent–seeking” and beggar-thy-
neighbor policies, which can increase one country’s welfare at the other country’s expense. Such
2. The assertion that the U.S. government should subsidize the domestic self-driving car industry
depends upon the benefits of this protection eventually exceeding the costs. This could happen if the
self-driving car industry is characterized by excess returns, with imperfect competition eventually
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externalities and technological spillovers that would justify support. Japan supported the growth of
the domestic Japanese semiconductor industry in the late 1970s. Though the Japanese industry did
grow to take a large share of the semiconductor market, it is not clear to what extent this was caused
by government policy (Japan may have had a natural comparative advantage in this industry).
Furthermore, Japanese dominance in semiconductors did not appear to generate the kind of
technological spillovers or excess returns that would have justified government support. Given this
experience, it is not clear that the U.S. government supporting the domestic self-driving car industry
would generate returns in excess of costs.
3. The results of basic research may be appropriated by a wider range of firms and industries than the
results of research applied to specific industrial applications. The benefits to the United States of
4. A subsidy is effective when the firm in the other country does not produce when the domestic firm
enters the market. As Tables 12-1 and 12-2 show, a subsidy may present a credible threat of entry and
5. A label guaranteeing that a product was produced by labor being paid a “fair” wage is not the same
thing as a tariff on low wage exports. With a product label, consumers in developed countries make a
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often, buy new appliances less frequently, etc. There will thus be less labor demand in places like
restaurants, retail outlets, etc. This result does not contradict the usual models of trade that job losses
in one industry are offset by gains in other industries. However, the gains and losses do not occur in
the same place. While it is possible for those who lost their jobs in one industry to move to an
expanding industry, this would require them to not only acquire the skills needed in the growing
industry, but to also physically move to a new location.