Prerequisites for Free Trade? Volume 1, Economic Analysis

Fair Trade and Harmonization: Prerequisites for Free Trade? Volume 1, Economic Analysis

Larudee, Mehrene

Fair Trade and Harmonization: Prerequisites for Free Trade? Volume 1, Economic Analysis. Edited by Jagdish Bhagwati and Robert E. Hudec. Cambridge, MIT Press, 1996. Pp. 598. $60.00. ISBN 0-262-02401-2.

This book attempts to answer the question “Under what circumstances is it appropriate for countries to harmonize their policies with respect to environmental standards, labor standards, tax policy, or antitrust issues?”. Although it comes to no overall conclusion, more often than not the authors find that harmonization is less than optimal.

Following an introductory section with overview essays, there are sections on environmental standards, on labor standards, on tax policy, on competition policy, on whether there is a “race to the bottom” in environmental standards, and on Japan and Europe. The book contains both theoretical essays, and empirical, historical and institutional essays. While I found the latter to be most useful and absorbing, probably the most controversial and widely discussed chapters will be the theoretical essays by Bhagwati and Srinivasan (on trade and the environment), by Brown, Deardorff and Stern (on trade and labor standards), and by Wilson (on whether there is a theoretical basis for a race to the bottom).

What I wish this book had is a greater diversity of views. Although some essays try to summarize the views of advocates of harmonization, many do so inadequately and ultimately miss the point. The standard concept of social welfare in economics, and used throughout this book, implies that an increase in corporate profit income is to be regarded as a contribution to social welfare on par with an increase in wage income. If a policy change brings gains exceeding losses (in the sense that winners could compensate losers and still have some gains left over), then this change is a welfare improvement.

I am prepared to bet big money that labor and environmental activists would almost unanimously reject this concept of social welfare, and they would have a good portion of the general public on their side. Moreover, economists cannot justify this definition of social welfare by their expertise. Their only available defense is that such a standard is convenient. But convenience has no moral standing, and economists have no more moral authority to set this as a measure of social welfare than does a person on the street.

Activists, I wager, take an even stronger position, arguing not just that an increase in corporate profits fails to compensate for a decline in labor’s standard of living (as reflected in health and safety standards, environmental standards, working conditions, and so forth), but that the increase in corporate profits itself has a negative effect on social welfare. Workers frustrated by their limited ability to win decent contracts from corporate management, or to gain legislation that protects them from workplace hazards, are not about to applaud higher corporate profits, which in their view will enhance the ability of corporate management to suppress strikes and buy political influence.

Because the book (or, to be fair, the economics profession) fails to address the welfare issue adequately, its arguments, were they understood by the public, would be unpersuasive. If the winners from these policies do not compensate the losers, then it is debatable whether the outcome is an improvement or a deterioration in welfare.

Given an ongoing conflict between corporations and citizens, or corporations and the communities in which they are located, some of the arguments presented in the theoretical essays are seen in a very different light. For example, in his essay on whether there is a race to the bottom in environmental standards, Wilson argues that in many circumstances a jurisdiction (city, state, country, etc.) will use policy instruments other than relaxation of environmental standards (such as tax breaks, or other subsidies) to attract investment. He concludes that in such circumstances there is no race to the bottom, by which he means that there is no such race in environmental standards. Activists would perhaps be astonished at this conclusion, and would argue that there is still a race to the bottom in these circumstances, but it does not happen to be in environmental standards.

Let me comment also on a second methodological issue. It is the practice in the profession to produce a profusion of models, based on a variety of different assumptions. Naturally, these different and often mutually exclusive assumptions can not all correspond to real world situations. It is also the practice, especially in theoretical papers, to give rather little discussion to the true nature of the real world we seek to model and understand. Leontief [1971, 3], among others, has criticized this trend: “preoccupation with imaginary, hypothetical, rather than with observable reality has gradually led to a distortion of the informal valuation scale used in our academic community to assess and to rank the scientific performance of its members.”

I submit that some of the theoretical essays make the same mistake. Of course, it is natural to introduce the simplest case first and then gradually to incorporate complexities. But ultimately the only thing that counts is the one model which best corresponds to the real-world situation; whatever is proved about the other models is irrelevant.

Wilson’s essay on whether there is a race to the bottom in environmental standards surveys a wide variety of results from the local public economics literature and concludes that in relatively few models can a race to the bottom in environmental standards be derived. But this is irrelevant. We do not decide truth by a majority vote of hypothetical models! The key question is which model or models represent the real situation most accurately. The several models that do result in a race to the bottom seem most to resemble what we actually observe. Included in this category are the models with imperfect competition (large firms with market power), and models in which jurisdictions each bargain with a single firm.

In the same vein, Brown, Deardorff and Stern’s essay on labor standards makes the standard assumption of identical and homothetic preferences. But based on ample experimental evidence we know that preferences are not homothetic. The assumption is not a harmless simplification; on the contrary, a preference for safe industrial workplaces is largely confined to those who have worked, or are likely to work, in such jobs, and this is a subset of the population.

It is worth mentioning several solid essays which contain informative historical, institutional or empirical discussions focused on a single point. One is Clarida’s fascinating argument that antidumping laws are used to protect U.S. industries too much, because the criterion used by government agencies to determine whether dumping has occurred is overly favorable to US firms. Another is Levinson’s essay summarizing the empirical evidence on whether lax environmental regulations are decisive in causing firms to relocate production; he concludes that there is little evidence that differences in environmental regulations play as large a role as factor costs, taxation, or other determinants. Still another is Saxonhouse’s remarkable account of unfair trade allegations made by the U.S. against Japan, packed with useful and surprising information. Slemrod’s discussion of tax policy contains, among other things, some golden nuggets of information on transfer pricing, a topic that deserves more attention in the trade and foreign investment literature.

Levinsohn’s essay on competitive policy deserves special mention for its exceptional effort to stay close to reality. He analyzes a series of different cases, and admirably refrains from adopting unrealistic assumptions; this makes it impossible for him to draw any single striking conclusion. It is an unfortunate fact that while this is often the more honest scientific approach, such work sometimes tends to be ignored because it has no single punch line; I hope this will not result in his important work being overlooked.

In sum, this volume is thought-provoking, and contains some useful information on the history and institutions related to the issue of harmonization; but it suffers from the narrowness of the views it represents. I hope it will provoke a deeper debate over the issues involved, particularly the central issue of how social welfare ought to be defined.


Leontief. W. Theoretical Assumptions and Nonobserved Facts. American Economic Review, March 1971, 1-7.

Mehrene Larudee

University of Kansas

Copyright Eastern Economic Association Spring 1999

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