naked capitalism

Dani Rodrik often thinks more like a political economist (which was the initial focus of the dismal science) than the development economist he professes to be, which I consider to be a plus. That perspective enables him to frame issues in ways that sometimes escape other observers.

Many discussions about economics often boil down to differences in values, with one camp advocating efficiency, the other fairness. The efficiency types have had the upper hand for the last couple of decades, but going too far in that direction, particularly when it runs afoul of perceived equity, can undermine the entire system. Behavioral finance experiment have repeatedly found that participants will reject deals that leave them better off if they feel the other side has been too greedy. The opportunity to punish their opponent becomes more valuable to them than the payoff from cooperating.

Although Rodrik’s comments below focus on trade, its implications extend beyond that.

From Rodrik:

Those who are puzzled by globalization anxiety and attribute it to collective irrationality (see Tyler Cowen’s piece in the NYT) overlook a fundamental aspect of markets–their “embeddedness.” What I am referring to is the idea that successful markets need to be embedded in a larger set of man-made rules and governance structures. Markets need regulation, stabilization, and legitimation because they are not self-regulating, self-stabilizing, or self-legitimizing. The success of modern capitalism is due as much to the institutions that govern markets–political democracy above all–as it is to the power of markets themselves.

It is important to understand this because it provides an important clue as to why domestic and international trade are different. Domestic trade takes place within thoroughly embedded markets; there are clear rules and they apply to all transactions equally. International trade, on the other hand, is conducted in only weakly embedded markets: the rules either do not exist or apply unevenly. I believe this is the fundamental reason why their consequences are often perceived so differently.

Let me make this concrete. If Harvard fires me and hires Tyler Cowen instead, I would feel bad for sure. But I would not blame Tyler or Harvard, because I would assume that the decision was made on fair grounds: we compete under the same ground rules, and if Tyler beat me to it, it must be because he deserves it.

But suppose instead that Harvard hires John Plagiarizer, who has a much longer vita and larger citation counts than either one of us, because… well because he is a flagrant plagiarizer. I think I would have pretty good reason to feel cheated.

An extreme example? Let me make it less so. Suppose that I am an experimental psychologist instead of an economist and the person Harvard hires in my place is someone who has accumulated a long vita by virtue of not having to abide by human subjects review standards. (You can find out a lot about human behavior through torture.) Would I not feel treated unfairly? You bet I would.

The international trade counterpart of this hypothetical is the worker who loses his job because his company decides to move to a country where, say, labor rights are routinely violated. So the “us” and “them” characterization that Tyler attributes to irrational nativism perhaps has more to do with the absence of a common set of international rules on labor standards, environment, consumer safety, and so on.

By overlooking the problems created by trade in instances where regulatory arbitrage does play an important role, we miss the opportunity to celebrate the kind of globalization where such arbitrage doesn’t play a role. The latter type of trade probably constitutes the bulk of world trade. But because economists do not make this important distinction, they have no language or ability with which they can respond appropriately to the uneasiness out there–except for calling it irrational.

And by the way, Harvard cannot fire me because I have tenure (as does Tyler). Which makes any pontification on our part about job anxiety a very poor guide to reality.