How Trade Actually Works

Somehow, Bernie Sanders and Donald Trump both managed to sell far-right, conservative trade policies to both the progressives and the conservatives. It’s not hard to see how: trade economics are far-abstracted from most people, and the isolated microeconomic effects are easy to showcase as a threat. Fear draws votes like nothing else, and telling people their lives and livelihoods are on the line is a great way to get elected.

Here we explain how trade can be so good yet so easily cast as bad, what the remedy should be, and how trade economics actually works. We use abbreviated abstractions and thought experiments because nobody wants to read a 470-page blog post in an attempt to develop a Ph.D. in macroeconomics. Real-world evidence consists of huge piles of mathematics and a lot of economists repeatedly being proven wrong about NAFTA destroying jobs.

Structural Change

Everything which makes the individual consumer wealthier also makes the nation wealthier. These things—technical progress and trade—involve structural change, or the reorganization of the factors of production. Such reorganization must impact someone, somewhere, negatively, which gives trade conservatives their cudgel.

In truth, even an entire collapsed city represents roughly 0.05% of the American economy. If your factories flee to Mexico or China, that’s all the damage. Immediately we must ask: why not just fix it?

While those 0.05% of Americans lose their jobs, the other 99.95% get richer. Some at the top get a lot richer, while consumers in general see lower prices relative to wages—so long as minimum wage keeps up—and thus can buy more goods and services. This reduces poverty.

So here’s a question: if 99.95% of us are, say, 0.5% richer, why can’t we all be 0.45% richer and shuffle the other 0.05% to compensate those impacted by structural change?

This is exactly what the American Citizen’s Dividend proposes. It’s also part of the purpose of universal healthcare, universal family care, unemployment insurance, welfare, and other social insurances and needs-based programs. Most of us are richer, and we’re so much richer we can compensate those who were in the path of progress so they can recover and share in the new wealth. Again, sharing in the new wealth includes a structural minimum wage.

The threat that your job might be the one to run off to Mexico overrides the abstract macroeconomics of progress—of greater wealth, higher standards-of-living, and lower poverty. It’s hard to sell the idea that growth means change and change might mean we as a society must take care of you from time to time. It’s exceedingly easy to sell the idea that lower costs mean higher profits and the rich are cutting our throats to make themselves richer while we get poorer.

Thought Experiment: Cars and Planes

Most folks can easily shrug off Ricardo’s theory of trade economics by claiming it’s all academic. Wikipedia effectively summarizes it in one graphic, and it looks like some kind of magic.

The blue triangle depicts Home’s original production (and consumption) possibilities. By trading, Home can also consume bundles in the pink triangle despite facing the same productions possibility frontier.

So let’s imagine the United States and China can both make cars and airplanes, and see how we get from blue to pink on both sides.

Assume the United States expends the same resources to make either one airplane or one thousand cars. Thus the United States can make ten airplanes and zero cars, ten thousand cars and zero planes, or five airplanes and five thousand cars.

In China, the manufacture of one airplane could instead produce merely one hundred cars. China, with the capacity to produce ten airplanes, can instead produce one thousand cars.

These are the same cars and the same planes made to exactly the same quality specifications. China just happens to be comparatively better at making planes: they sacrifice the capacity to make fewer cars for each plane.

Okay, what do we do about it?

If each nation allocates resources evenly, the United States can produce five airplanes and five thousand cars, while China produces five airplanes and five hundred cars. That’s ten airplanes and 5,500 cars.

Let’s trade with China.

The United States instead produces ten thousand cars, while China produces only ten airplanes. We still have ten airplanes, but also ten thousand cars. That’s a net gain of 4,500 cars while expending the same resources.

Already we see just how we’re doing the same work yet getting more simply by trading.

Impacts on Consumers

How does trading cars for planes affect each trading partner?

  • China can import 4,500 cars for the cost of, at most, 500 Chinese-made cars. An American car costs the Chinese consumer a minimum of 1/9 that of purchasing a Chinese car.
  • America can import 5 planes for the cost of, at most, 4.5 American planes.

Notice there are minimums and maximums here. The prices can fill that broad gap just about anywhere, and will rarely turn out optimal. Competition tends to drive prices to the lower end, although new trade theory (below) reduces competition and still lowers prices.

Wages and Exchange Rates

There’s another issue: these are comparative advantages. It might very well require twice the Chinese labor to make an American plane, and it’s still only a good deal for America below 90% of the price of an American-made plane. It’s still worth trading.

In such a situation, exchange rates will adjust such that the Chinese wage, in American dollars, is only 45% of the American wage. Rather than 1/9, that American car will cost the Chinese worker 1/4 of what a Chinese-made car will. That still means they labor for only 25% as long to purchase a car.

Often we hear about the exploitation of third-world labor, yet we don’t talk about the crisis of unemployment they’d face without these or other jobs. We certainly don’t discuss why those wages are so low, or talk about how quickly those wages are growing, or the simple increase in standard-of-living among these workers.

The comparative advantage explains many of these things. It also cuts off an important argument: that trade is only sustainable (cheap) because labor and environmental standards are lax in these countries. Trade would be profitable for both sides even with strict environmental standards and basic labor practices. You’re never going to get trading-partner wage parity, but you can get GNI-share wage floors (and a lower exchange rate).

New Trade Theroy

There’s one more component to trade theory: Paul Krugman’s New Trade Theory, for which he was awarded the Sveriges Risbank prize in Economics in honor of Alfred Nobel.

New Trade Theory simply observes that accumulation of the factors of production can provide a type of wealth-creating structural change. If you want to make large-body airplanes, you need a lot of resources in huge factories to make not a lot of units. With only two such factories in the world in two different countries, the cost of making large-body airplanes falls thanks to economic efficiencies of scale.

This is why Ford and GM no longer make everything in one place. Making all the different factory parts and all the different cars in one factory involves a lot of work stoppages, retooling, and other labor-wasting effort. Interchanging common parts and making a narrow range of things in each dedicated factory keeps the assembly line rolling, and the cost per unit falls.

Because the United States is busy trying to fix a nursing shortage and build a STEM workforce, we run a little short on labor, so we have Mexico and Canada and China make a lot of cars and car parts, and we ship things around. We’ve also gotten extremely productive in manufacture, able to manufacture far more with a smaller labor force, so manufacture in general has grown less while other industries have grown more.

Put all of that together and you see a lot of odd things happen. You see entire industries vanish even as they get bigger. You see cheap shirts coming out of China, made from fabric dyed in Indonesia or India, dyed from textile manufacture in the United States, woven from cotton grown in the United States or Egypt. You see language like “Assembled in Michigan” on cars that are made in Japan, Germany, the United States, Mexico, China, Sweden, and Canada, with materials and parts shipping repeatedly back and forth between these nations just to make one vehicle.

You see people with little grasp beyond that their job might go to China, because even the economists can’t really get their heads around trade.

Those people are prey for deceptive politicians with conservative trade policies.

Illustrations of Electoral Failures

Many people find electoral systems abstract and esoteric. Party primary and plurality seem like obvious, fair systems, yet draw large amounts of attention for their unfair results and damage to our democracy; and the Electoral College gets attention when it disagrees with that same often-maligned popular vote system, ironically creating a call for a national popular vote. People aren’t generally experts in the economics of social decision making, and only recognize that there is absolutely something wrong here.

Fortunately, people are in general intelligent and capable of understanding complex concepts if someone explains them well enough. For complex electoral systems, we can use the United States 2016 Presidential Election as a frame of reference, and propose several different sets of votes. From these votes, we can calculate outcomes and show how each electoral system fails.

We must understand upfront the utmost importance of representation. Our elections must produce a representative result. That representation might not fit with what we as individuals or larger groups want; that’s not the point. The point is for us, as a majority, minority, or whatever portion, to have our say and to influence the election so that every vote counts—that means we must concede some things sometimes.

To emphasize this point, I’ve used a model in which there are more Republicans voting than Democrats in the 2016 election. In general, this means a Republican wins—but which Republican? That’s the key question.

In our first example, we have 24% ranking Rubio, then Trump, then Clinton: we’ve assumed the Republicans will always vote Republican first.

As seen above, Plurality selects only from first-ranked votes. More voters—a full 30%—voted Trump than anyone else, so Trump wins. We can see how flawed a system this is.

Party Primary is actually worse. In the real 2016 Republican primary, Trump won with 44% of the votes thanks to the same vote splitting seen above. The Party Primary system also faces non-mathematical flaws rooted in human economic behavior.

Party-line voters who don’t care who wins the primary are less-inclined to vote. In practice, you might see 75% of the Sanders voters turn out, and only 50% of the Clinton voters. Using our example here, with more Democrats preferring Clinton, Sanders would achieve a victory at 54% to 46% in the primary. Social media propaganda attacks capitalize heavily on this problem.

Our example also shows a top-two system, which just picks Trump and Clinton by plurality vote. Again, Trump wins.

Majority Runoff and its ranked choice voting version, Instant Runoff Voting, show the center squeeze effect: least-voted Bernie Sanders gets booted early, sending votes to Clinton. Clinton and Trump thus squeeze out Rubio, turning this into a Clinton-Trump contest, in which Clinton wins.

The last example is our Condorcet method. The graph on the right holds particular importance: it shows who defeats who, with the arrows pointing toward the losers in one-on-one contests.

Because Rubio defeats Trump, Clinton, and Sanders in the respective two-candidate elections, Rubio is the Condorcet winner. Systems like Tideman’s Alternative elect this winner, representing a consensus of the voters.

So okay, there were more Republicans, and Rubio wins under this system. Does that mean this is a better system, or is it just electing a candidate some of us personally dislike less than the winner?

Those aren’t mutually-exclusive propositions: 70% of voters preferred Rubio to Trump. A lot of us apparently personally disliked Rubio less than Trump, yet Trump got elected. Trump got elected despite a majority of voters not wanting to elect Trump.

Let’s fiddle with the numbers a little.

Hillary Clinton won the popular vote in 2016. A large body of Never-Trump Republicans had no alternative but to vote Clinton, and the above illustration supposes Clinton won the popular vote because of a great many Republicans ranking Rubio, then Clinton, then Trump. The Electoral College essentially stuffed these Republicans into strong Red jurisdictions, covering up their votes just like gerrymandering, so Trump won anyway.

Again, Trump wins Plurality; and again, Rubio remains the Condorcet candidate—so far, the correct winner, given the arguments above. What about the other systems?

Party Primary selects Clinton and Trump. This removes Rubio. The graph shows Rubio defeats Clinton, who defeats Trump; since Rubio has been removed, Clinton wins. Just as with Trump, 54% of the voters preferred Rubio to Clinton.

Top-Two again selects Clinton, and Rubio voters bail out on Trump. Runoff and Instant Runoff Voting also squeeze out Rubio, leading to a Clinton victory.

Even though the majority of the voters clearly prefer Rubio to Trump, Clinton, and Bernie, only the Condorcet system elects Rubio. The rest fail, this time electing Clinton instead of Trump.

A small, unimportant change to the votes has a big change to the outcome. How badly can this fail, anyway? Let’s find out what happens if fewer people vote Trump and more people vote Bernie Sanders.

Sanders is now preferred among Democrats; Rubio voters still prefer Clinton to Trump, which elected Clinton in our second example; and one percent of voters have moved from the Trump camp to the Never-Trump camp.

Plurality still elects Trump, who has the most votes—no surprise there. A Condorcet system still picks Rubio.

Party Primary now selects Bernie Sanders. Sanders can’t beat Trump, so Trump wins. Voting for Bernie instead of Clinton elected Trump.

Top-Two actually gets it right for once. Because more people voted for Rubio, the line-up is Rubio versus Trump, and Rubio beats everybody.

This outcome is precarious: if more than 1% of voters additionally switched from Clinton to Bernie, Top-Two would have selected a Bernie-Trump election, and Trump wins—once again, voting for Bernie Sanders elects Donald Trump. This should never happen, yet it keeps happening.

Runoff and Instant Runoff Voting again center-squeeze. This time it’s Bernie defeating Clinton, instead of Clinton defeating Bernie; and then Rubio goes, leaving a Bernie-Trump election once again. Instant Runoff Voting elects Trump—and once again, changing your vote from Clinton to Sanders elects Trump.

That’s all fine, but what if nobody’s on top?

Enter strategic bloc voting. The Trump voters are trying to eliminate Rubio by burying under Sanders—a known flaw that can manipulate Condorcet systems. Tideman’s Alternative carries a high degree of resistance.

In this example, Plurality elects Trump, Top-Two picks Rubio, and both Party Primary and run-off elect Clinton. Trump voters have identified Sanders as the weakest candidate, and so buried Rubio under Sanders.

The attack works fairly well: Sanders defeats Rubio and Clinton. Rubio defeats Clinton, who defeats Trump, who defeats Sanders; and Rubio defeats Trump, who defeats Sanders.

From any candidate, you can find a path of victories leading back to that candidate. Rubio defeats Clinton, who defeats Trump, who defeats Sanders, who defeats Rubio. Looks like we don’t have a Condorcet candidate, and every candidate except Sanders seems to win under these systems, so how do we decide who wins?

Enter Tideman’s Alternative.

Tideman’s Alternative identifies the top cycle—in this case the Smith Set, which is those candidates who are not defeated by any candidate not in the Smith Set.

To better illustrate, this example includes Gary Johnson, defeated by everybody. The green arrows show the Smith Set path. None of the candidates in the Smith Set are defeated by Johnson. You can trace a path of victories from any candidate in the Smith Set to any candidate in the election.

Tideman’s Alternative eliminates all non-Smith candidates—that being Johnson—and then performs one round of run-off (sometimes called “alternative vote”). This eliminates Sanders, leaving Rubio, Trump, and Clinton.

In round 2, the Smith set is Rubio. This makes Rubio the Condorcet winner, and so Tideman’s Alternative elects Rubio.

As shown here, Tideman’s Alternative can reliably find a consensus winner, and resists tactical manipulation. It does have failure modes, but those failures rely on a large amount of manipulation: Sanders defeated all non-Trump candidates in this example, so even if Rubio voters voted Rubio, then Trump, then Sanders in an attempt to bury Clinton, the outcome wouldn’t change.

The failure modes can also be unpleasant. Consider this attack if 4% more of the voter were Trump voters instead of Rubio voters.

Here we see more Trump voters and fewer Rubio voters. An honest vote, with Trump voters placing Rubio second, elects Rubio; but the Condorcet burying attack changes the outcome.

By attempting to corrupt our elections through tactical manipulation of their voting ranks—by ranking not by the order they favor, but rather in an attempt to mathematically distort the outcome—Trump voters succeed in electing Hillary Clinton.

This happens because a few Rubio voters are honestly opposed to Trump—these are the Never-Trump voters who voted Clinton in 2016. This attack also requires Trump to be the stronger candidate—and Trump won 44% of the Republican Primary, in which the more-moderate independent voters can’t even vote.

To make this clear: if just over 4% of Rubio voters defect to Clinton, Trump has fewer than 50% of the votes. Clinton has around 28%, and Sanders is eliminated. Sanders votes go to Clinton, granting over 50% of the votes, a Clinton victory. That mean this attack elects Clinton even if almost no Rubio voters reject Trump.

Our electoral system matters. Our elections need to find the consensus of voters, not the end result of manipulations and errors. We’re not here to elect a winner, but a representative.