By Servass Storm, Department of Economics, Faculty TPM, Delft University of Technology and Pierre Kohler an Economic Affairs Officer at UNDESA whose research focuses on sustainability, redistributive policies as well as on global macroeconomic models applied to trade and fiscal policy
Things have changed. Until just a few weeks ago it was easy for economists and trade policymakers to discard the massive waves of protest across European countries against two controversial transatlantic free trade agreements as mere “irrational”, “protectionist” or “dangerously populist” impulses. But not so anymore. About the same time when hundreds of thousands of concerned German citizens took to the streets to protest against the Transatlantic Trade and Investment Partnership (TTIP) and the Comprehensive Economic and Trade Agreement (CETA), a growing chorus of senior policymakers started urging governments to heed the rising discontent, anxiety and economic insecurity among the vast majority of the populations in the advanced world.
Most prominently, in a speech titled “Making Globalisation Work For All” given in Canada on September 13th, I.M.F. managing director Ms. Christine Lagarde stated that many people felt they “lack control” in a “system [that] is somehow against them” and that growing inequalities have “added to a groundswell of discontent, especially in the industrialized world.” Lagarde’s plea for boosting support for low-income workers and reducing inequality came on exactly the same day Mr. Mario Draghi, the president of the E.C.B. stated —in his Premio De Gasperi lecture in Trento, Italy—that the E.U. should pay greater attention to “the demands of those left behind by a society built on the pursuit of wealth and power”, and do more to help globalization’s losers by moderating its outcomes. Globalization has certainly caused dislocation and hardship, as the recent McKinsey report titled “Poorer than Their Parents? Flat or Falling Incomes in Advanced Economies” found: 65 to 70% of households in 25 advanced economies had experienced no real income growth between 2005 and 2014, up from just 2 percent of households with stagnant incomes during 1993-2005. This was known, of course, but McKinsey’s report helped publicize the facts.
The bottom line should be clear: citizens are rightly concerned about the distributional consequences of TTIP and CETA — a concern which policymakers and politicians can ignore only at their own peril. The justified skepticism of German voters has already dealt a possibly fatal blow to TTIP negotiations. Sigmar Gabriel, Germany’s vice-chancellor and economics minister, and an early proponent of TTIP, admitted last month that negotiations had “de facto failed”. However, while TTIP may have reached a dead end, the CETA trade deal between the E.U. and Canada is on its way to ratification, albeit on increasingly rocky ground. The CETA deal has the political support of key European social democrats, such as the SPD’s Gabriel but also French President Francois Hollande and the Dutch PvdA Minister for Trade Liliane Ploumen, who point to economic studies that unequivocally predict that CETA will raise incomes and create additional jobs in the E.U. CETA will supposedly benefit “left-behind” constituencies—which would make the concerns of Ms. Lagarde and Mr. Draghi appear unwarranted. We must note right here that these estimated unequivocal income gains are extremely small—less than 0.1% of GDP in 2023.
However, CETA proponents fail to point out that the standard economic model studies on the effects of CETA, on which they are basing their claims, are incapable of tracing out any distributional consequences of the agreement, because they assume that the Canadian and European economies always operate at full employment. In addition, these studies manage to inflate the so-called dynamic gains from the trade agreement, by assuming that all (extra) savings are automatically re-invested into the real economy. Both assumptions are empirically untenable and combined they help define away the real problem: trade liberalization in these models is “win-win” by design of the modeler, who assumes away unemployment, shortage of investment, and any adjustment costs or uncertainties (associated with searching new jobs, moving houses, going for additional schooling, closing down one’s factory, taking a new loan for setting up a new firm).
In a recent Tufts University working paper, we provide alternative projections of CETA’s economic effects in which we allow for changes in employment and income distribution and the economic adjustment to the trade deal is modelled in a realistic and empirically grounded manner. In contrast to the “win-win” outcomes, we find that CETA will lead to intra-E.U. trade diversion and to net losses in terms of employment, personal incomes and GDP in both Canada and the E.U. By 2023, we project that 30 thousand jobs will be lost in Canada and 200 thousand jobs in the E.U. Higher unemployment will depress wage growth and by 2023, workers will have foregone average annual earnings of €1776 in Canada and between €316 and €1331 in the E.U. depending on the country (compared to the base run without CETA). Aggregate demand shortfalls nurtured by heightened unemployment will also hurt productivity and cause a decline in national income of 0.96% in Canada and 0.49% in the EU.
We do not, of course, claim to possess perfect foresight. But we can claim that our model analysis is based on more realistic assumptions than the standard full-employment models—and that unlike these earlier studies, we face up to the risks, the distributional impacts and the non-negligible transitional costs of freeing trade—which are worrying not just Ms. Lagarde and Mr. Draghi but also the majority of the European and Canadian citizens. We concur with Mr. Draghi that further fragmentation of our already divided societies will be “most dangerous” politically and carries the risk of reversing integration. It is high time that Europe’s and Canada’s policymakers wake up to the fact that freeing trade does not necessarily create extra jobs but instead carries a high risk of welfare losses, heightened inequality and fragmentation—all sources feeding the groundswell of discontent. The decision on CETA needs to be an informed decision—one that takes the many downsides of the trade agreement very seriously.