The Political Economy of the Capital / Labor Trade
In this post, I want to try to explain why the current administration, and actors from other parts of the political spectrum, think that there’s a problem with persistently trading capital for labor. The first thing to clarify is that the best versions of these arguments tend to focus on political economy rather than the straightforward measures of welfare (money) that most trade economists study. The concern is that trading capital for labor may affect the role of labor in American society in ways that disempower and humiliate the middle class even while it increases their economically-measured welfare.
The tl;dr of my take on this is that this is a valid concern, but the recently-announced tariffs, as well as the other prominent proposals to deal with these concerns, are not going to succesfully do what the concerned-parties want them to. That sounds very milquetoast, so I’ll be more clear and say that I think most of this stuff is just a massive waste of money and/or just corruption aimed at enriching Trump or Biden’s clients.
A lot of people in both of these political coalitions have an instinct that this is the case, but they don’t have the theoretical tools to explain why what’s going on is bad. A big part of the problem is that the arguments typically used to defend free trade are only focused on welfare, which skeptics of trading capital for labor are not trying to maximize. In fact, a lot of them explicitly admit that their policies will reduce welfare but claim it’s worth it because Americans are already wealthy and what they really need is to repair the political economy problems of the declining middle class. So I hope to make a contribution by arguing in a way that shares a willingness to prioritize political economy problems over welfare––but nonetheless finds a fatal means/ends mismatch between the policies that have been used so far to address this and the objectives of those policies.
The Labor Economics of Trade in Mainstream Economic Theory
Economists have long been aware that production factor abundance gaps, namely the capital / labor abundance gaps that drive our trade surprlus, can cause negative consequences for labor. If a capital-rich labor-poor (these are relative comparisions) state trades with a labor-rich capital-poor state, then we would expect wages in the capital-rich state to fall. Consider an illustration of the prominent Stolper-Samuelson theorem, a great example of how lots of economists think about trade:
Economists tend to think that the depicted wage decrease is fine because total welfare goes up. Since scarce resources get employed more productively: “the pie gets bigger.” Any changes in ex ante distribution can be addressed through ex post redistribution: “more pie for everyone.”
As the above tweet suggests, some people are cynical about this story. Awarding large gains to capital-owners who are already wealthy, at the expense of middle-class laborers––even when the size of the capitalist gains outweighs the losses of laborers, reinforces the collective action difficulties of redistribution1. The amount of redistribution we choose is not exogenous wrt existing wealth distributions. In simple English, the more wealth gets concentrated in a few people’s hands, the more power they have, and the better they will be able to prevent any redistribution to wider shares of the population.
There’s some empirical support for this being the right story to tell about the last 30 years of decreasing trade barriers:
Household incomes, after redistributive policies, haven’t increased much for most Americans, even as the pie has gotten a lot bigger. So, you might think that redistributing gains to capital under free trade isn’t very realistic because capitalists will use the additional power they acquire from their gains to prevent exactly the redistribution that makes those gains worth it for laborers. Limiting trade may therefore look like a good––perhaps the only––way to maintain a high labor income share even though it involves giving up some potential gains.
The question then is whether departures from classical free trade, like tariffs or subsidies, can address this issue. The first concern is that tariffs are more regressive than tax-and-transfer redistribution. The Trump administration has put forth some zany theories on tariff incidence based on FX markets, but the literature has documented clearly that tariffs have some incidence on consumption, and therefore are like any consumption tax, regressive.
Another issue is that the same political economy dynamics of political capture apply to tariffs. If tariffs are a second-best alternative to redistribution, then as soon as the wealthy realize this, they will use their anti-redistribution channels of political influence to prevent tariffs. Even if a momentary political coalition such as the current administration can maneuver around this, in the long run we wouldn’t expect tariffs to be any more durable as a form of redistribution than tax-and-transfer schemes.
Infant Industry Theory
Another theory of tariffs focuses not on labor economics but rather on the notion of infant industry and comparative advantage. The classical theory of Ricardian trade, of which the Stolper-Samuelson theorem discussed above is an additional gloss, says that states should have free trade because they will be most productive specializing in their strongest industries and should import the rest of their consumption basket by trading the output of those strong industries.
A prominent response to this recommendation is based on the notion that comparative advantage is not fixed and can in fact be made by states. For advanced forms of industrial production like computer chips or jet engines, a big component of comparative advantage is the existing expertise of the production community. A state could intentionally develop a community of producers who are knowledgeable about these industries through direct investment in R&D and by shielding the industry from superior foreign competitors until it has developed enough of a comparative advantage to be profitable. That would eventually increase the total welfare of the economy by acquiring new comparative advantages.
A truly classical economist would have to say that investors know this and price it in, hence there shouldn’t be any market failures. But if you concede that investors can be nervous about making bold leaps on industries that may not be profitable for decades, then you can see why there might be a role for government intervention here. The prescription would then be for targeted tariffs and subsidies to help these industries thrive before they have built up enough expertise to compete on the world market.
This theory is a much better fit with the Biden policies of subsidies in computer chips and EVs than it is for Trump’s across the board tariffs. However, there is still a big problem as it applies to the actual long-run competitiveness of the targeted infant industries. That problem has to do with the underlying labor / capital abundance mismatch between the United States and its competitors.
Here, when we talk about abundance, what we are really talking about is price. It doesn’t matter how many laborers are actually available in the population if they are more expensive for an industry to employ. The price of labor is the laborer’s wage. So, if wages are higher, then labor shows up as less abundant in the context of Stolper-Samuelson comparative advantage theorizing.
Consider OECD data on average wages:
Labor in the United States costs around 25% more than its competitors for advanced industry in Europe, and almost 75% more than its developed East Asian competitors like Japan and ROK. The case of China need not even be mentioned.
The basic issue I’m driving at is that wages in the United States are much higher than our competitors in infant industry spaces like EVs or computer chips. So, even if you could develop as much existing expertise in those industries as counterparties like Germany, Japan, or China, it would still be cheaper to produce those products in those countries. Even where the expertise component of comparative advantage can be matched by infant industry support, you still have to deal with the labor component.
As a structurally capital-abundant economy, it’s unlikely the United States could ever be competitive on that front. While infant industry tariffs or subsidies could add to U.S. welfare in some cases, we would expect this to be true only in industries with low labor intensity.2 I’m not saying we shouldn’t try to develop any of these industries, but you wouldn’t expect most Americans to get richer by doing this. Any labor-intensive production relocated to the United States will pass on the costs of its labor inefficiencies to the consumer, deadweight loss included.
In fact, the infant-industry theory tends towards suppressing wages, whereas the redistribution theory calls for increasing them. If one is trying to help an industry that is currently non-competitive but promises to become so in the future, then one wants to direct all available resources within that industry towards investment. The basic problem an infant industry faces is that it cannot produce cheaply enough to survive against global competitors. In order for that industry to survive, it must either be insulated from global competition and developed exclusively within the domestic market–or it must be subsidized such that it can afford to sell below its marginal cost.
In both cases, the greater the labor share of income for the industry, the longer it will take to eventually become competitive, and the more expensive it is to make it become so. Even if you can artifically increase labor compensation in ways that aren’t incident on the industry (i.e. by labor subdidies), the cost of those subsidies will be incident on other laborers through taxation or inflation. The bottom line is that infant industry wealth creation won’t look like creating lots of good middle class jobs, and if one does not distinguish between the two theories, then one will be unable to form an effective industrial policy that accomplishes either of the aims laid out previously.
A Materialist Account of Democracy
So far, we’ve seen that tariffs and subsidies don’t look compelling from the persecptive of mainstream econ––neither as a substitute for redistribution or as a way of making labor-intensive infant industries eventually competitive, and you certainly can’t do both at the same time. But since the premise of this post is that mainstream econ defenders of free trade are talking past their critics by focusing on welfare, we should now look at what the non-welfare considerations associated with tariffs are.
Aristotle provides a great account of the relevant political economy dynamics when he discusses the relationship between military strategy and form of government:
When the country is adapted for cavalry, then a strong oligarchy is likely to be established. For the security of the inhabitants depends upon a force of this sort, and only rich men can afford to keep horses. The second form of oligarchy prevails when the country is adapted to heavy infantry; for this service is better suited to the rich than to the poor. But the light-armed and the naval element are wholly democratic; and nowadays, where they are numerous, if the two parties quarrel, the oligarchy are often worsted by them in the struggle…the oligarchy should also yield a share in the government to the people, either.
The idea here is that when a state depends on a certain body of people for its defense, it is likely to and almost compelled to award that body of people with advantages such as political agency and basic respect. I believe free trade critics have a similar instinct about economic production, which is arguably just as important, and is in some ways constitutive of military power in an age of industrial combat. Adjusting for the different role of producton in Aristotle’s pre-industrial world, we can say that on the basis of his theory, the more a broad range of laborers plays a role in economic production, the more respect, dignity, and political agency they will command.
We’ve already discussed how people in concentrated interest groups, such as the wealthy or coalitions of affectively-tied bureaucrats, tend to be better at political influence because it’s easier for them to solve collective action problems. So if laborers can’t directly influence politics as well as these groups, then the good way to look out for their welfare would be for the aforementioned groups to be incentivized to care about laborers.
The more the performance of the economy depends on the health and wellbeing of its laborers (as opposed to its ability to package and sell assets), the more capitalists and government officials will care about said health and wellbeing. The subjective experience of being a middle-class laborer also changes in proportion to the role of labor in the economy. The more important the laborer is in ordinary production, the greater sense of respect and self-sufficiency we would expect laborers to feel. Think about the difference between commanding a middle-class wage on the market vs receiving redistributionary income from inscrutable political processes in Washington.
Now that we’ve gained an appreciation for the kinds of non-welfare concerns that motivate skeptics of trading capital for labor, we can reconsider the wisdom of departures from classical free trade. How would industries shielded from labor arbitrage affect the subjective experience and political agency of middle-class laborers? One might think that by putting giving laborers a better role in production by preventing Stolper-Samuelson factors from equilibrating across borders, laborers will acquire those goods.
But I’m skeptical of this because I think such barriers behave quite similarly to redistribution. Recall Aristotle’s suggestion that an oligarchy award political power and recognition to the masses if it depends on them for military power. The converse of this recommendation would be to maintain a kind of illusory oligarchy-in-name-only: a polity governed on its face by and for a few but in reality necessarily oriented to the masses. My point here is that when a state tries to maintain a certain political form in the face of materialist developments that undermine that form, the result is often that the form becomes a contemptible mask of what’s really going on.
I have to think that tariffs and subsidies would behave similarly. While on their face, they would maintain an important role for laborers in industrial production, in reality, everyone would know that this role is maintained by costly government policies. Capitalists and political officials, rather than gaining respect for the laborer based on his essential contributions to the economy, would comport themsleves patronizingly and indifferently towards a class that they would regard as the recipients of an inefficient handout. The consumer class, in an age of social media, would surely resent people in other countries enjoying cheaper and superior products.
Although industrial production was associated with an age of higher respect and agency for the American labor in the past, the reasons for that state of affairs went beyond the inherent poliitcal economy character of industrial production. That production really was the force powering the American economy. But to bring it back with tariffs and subsidies today would not create this same effect. Everyone with eyes to see would recognize the subsidized industries as a dressed up redistribution scheme, which would do nothing to solve the political economy problems discussed in this section.
Constructive Moderate Solutions
Adam Tooze, who has more articulately expressed sympathy with both the above political economy story and the conventional econ critiques of tariffs and subsidies, often talks about reimagining the service economy. That’s obviously the right move to give the American laborer an honored and important role in society without paying the high costs of shielding our markets from superior industrial producers.
A lot of people dismiss this thinking as silly because their paradigm of service work is made up of stressful, sporadic, and spritually-inegalitarian forms of work like uber driving or waiting tables. They think there’s no way that a sector made up of jobs like that could ever lend the dignity that industrial production once did, which is precisely why they choose to advocate for costly and inefficient ways to revive that production.
But there are in fact lots of ways that Americans could make life better for each other without needing to compete with jurisdictions where even highly-skilled specialists are paid wages of $40k. I’ve spent a lot of time in “undeveloped” countries like Uzbekistan and Latvia, where I observed consistently cleaner and safer public life than what exists in the United States. A lot of this cleanliness, safety, and sense of order is generated by the constant presence of employees responsible for the space. Equipping American public spaces with these kinds of services would generate lots of local employment and create value for the community in a way that everyone could respect.
Another opportunity has to do with architecture. We’ve all seen the kind of cheap and ugly construction below that makes up a lot of the new housing supply in the United States:
Constrast this with older architecture, which is often decorated with ironwork and masonry. To provide this level of expertise for housing across the country, a large network of skilled laborers would be needed. While the opportunities I mentioned in the paragraph above might make for a good entry-level position in the laborforce, working as a skilled laborer to improve public and private buildings would make more sense as a career appropriate for later stages of life.
Another underexploited area––though not exactly service work––is food production. The United States has an enormous supply of land, a primary and scarce input in food production––especially dairy and ranching. While our food supply is reputationally associated with poor quality and agribusiness toxicity, our land endowment points to a different future. Large dairies and ranches, with high-paying, middle-class jobs and extremely stringent quality standards, could be created on federal land. The United States could easily become a world-leading producer of high-quality organic meat and dairy.
Consider the contrast between this last option and widget production. The problem with the latter, as I said in the last section, is that widgets are commoditized, i.e. they are all the same, and people in other countries can make them for much cheaper than American workers can. Therefore, any attempt to rebuild the importance of American labor through widget production will inevitably entail shielding such production from the rest of the market. Rather than promoting respect for labor, these policies are likely to be seen as a wasteful and unjustified transfer, and rightfully so. When accounting for deadweight loss, regressive consumer surplus loss, and the necessity to compensate capital investors with reasonable margins, setting up uncompetitive widget production is an extremely wasteful way to accomplish the task of giving a broad range of laborers an opportunity to contribute meaningfully to the economy.
On the other hand, producing healthy, high-quality food for the entire country is likely to engender respect even if some government intervention is required maintain the high standards. We might also expect that workers would rather spend time outside on beautiful federal lands than work in factories making batteries and computer chips. When we consider the quality of the experience for the worker, the cost / wastefulness of the proposed intervention, and whether the output meaningfully improves American society, it seems obvious to me that investing in production of things like healthy food is a more attractive choice than subsidizing uncompetitive electronics manufacturing, a process so unpleasant for workers that prominent East Asian firms have entire teams dedicated to preventing worker suicide.
A last and more radical option, which Tooze also highlights, involves a devaluation of the dollar:
If your aim is restoring the competitive position of US industry, a large dollar devaluation would do more than a sprinkling of industrial subsidies. But how to engineer one in the face of global demand for US financial assets is anyone’s guess. There is discussion of a tariff on foreign capital inflows, in effect a tax on the dollar as a reserve currency. But for such a radical policy to see the light of day would require producer interests to dethrone Wall Street — nothing short of a revolution.
This seems like a good idea to me and could easily be accomplished by some form of reverse capital controls. It’s probably true that even though competing in commoditized widget markets with East Asian economies is a bad idea, we should reduce our trade deficit to more sustainable levels. So, I’m not against some move like this, which would entail the market selecting our competitive industries rather than government officials doling out subsidies and tariff protections to their clients. Some industrial production will certainly thrive in such a world, but it will be production selected for comparative advantage rather than popularity with VC donors.
I think the takeaway for those sympathetic to the moves away from free trade that have been made in the last decade should be this: you aren’t crazy to think that there’s something wrong with the capital / labor trade, but the economists are right that you aren’t going to fix those problems with tariffs-qua-redistribution or by subsidizing and protecting infant industries. The actual political economy problems with trading capital for labor will only be addressed by identifying ways for laborers to make essential contributions that don’t depend on erecting artifical barriers to trade in commoditized widget markets. Luckily, there are many such opportunities in American life, and everyone would be better served by focusing on them directly instead of trying to tinker with the strucutral tendency for the economy to trade capital for labor.
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In general, we expect small groups to be better at solving a collective action problem such as lobbying the government for favorable policies. That’s because coordination is easier with small groups and because each potential defector weighs more strongly on the probability of the collective action succeeding. ↩
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Another problem: the simplest version of the Stolper-Samuelson theorem assumes unlimited factor mobility, i.e. the ability to redeploy capital and labor to maximize their return. But there is limited factor mobility between educated and non-educated laborers (since education takes time and is expensive). So, given the high abundance of educated labor in the United States, we would expect a fortiori that any labor-intensive industries would disproportionately draw on this factor rather than a broad range of the middle class. ↩