To respond to inequality, as well as the perceptions that the economy is “rigged” and deals like NAFTA are to blame, trade must become more inclusive.

The past year featured plenty of drama in international trade. Major developments included Brexit; obstacles to the secure passage of the Canada-EU trade deal; the US withdrawal from the Trans-Pacific Partnership (TPP); and the impending renegotiation of NAFTA.

In some ways, the heightened political and public scrutiny of trade is a welcome development. It shines a light on important policy issues, such as who determines trade rules, who benefits from them, and whether the sovereignty of national governments is unduly constrained.

Meanwhile, opportunistic politicians, such as Donald Trump, have projected broader economic anxieties around globalization, technological change, inequality and inclusion onto the more concrete target of trade deals (figure 1).

These broader anxieties are understandable and important. In recent decades, those higher up the income distribution have enjoyed the largest gains from growth in Canada (figure 2). The longer-term rise in inequality occurred in many developed countries, due to a variety of global factors and domestic policy changes that interact with but extend well beyond trade. Yes, the strong growth of top incomes reflects, in part, highly skilled workers who benefit greatly from using new technologies in a globalized economy to raise their productivity and expand their reach. But this isn’t simply a case of “just rewards” for the talented or lucky few; bargaining power has also shifted away from labour towards senior executives and capital. Part of the reason those at the top have captured a bigger share of national income is probably due to “rent extraction” (i.e., receiving excessive earnings relative to market-determined fundamentals) in industries such as finance and natural resources.

 

But what’s more disconcerting than elevated inequality is its persistence across generations. Miles Corak’s research suggests that both ends of the income distribution act like a magnet for families over time: there are poverty traps at the very bottom with limited chances for relative upward mobility, and “cycles of privilege” at the very top (figure 3).

 

Such results raise questions about fairness. And while economists often expect “fair” labour market outcomes — insofar as wages are thought to track productivity — instead, productivity and wages have decoupled (figure 4). As a result, the significant economic growth experienced over time hasn’t been reflected in the wages received by the typical worker. These outcomes help explain why the average voter may feel that the economy has primarily been working to benefit the rich. And this sentiment that the economy is “rigged” leaves these voters receptive to overly simplistic political arguments that trade deals like NAFTA are the main reason for their struggles.


The way forward: A more comprehensive and inclusive approach to trade policy

Even if you accept that many of these recent trade criticisms are ultimately about perception of unfair labour market outcomes, to which trade is one partial contributor, does this mean that trade policy-makers are off the hook? In the IRPP’s trade volume, Ari Van Assche, Robert Wolfe and I conclude that, in response to new global trade realities — which include concerns about trade deals, as well as the globalization of production and other structural changes in the economy — we must rethink our approach to trade policy.

First, as both the scope of trade-related activities and trade-focused criticisms have broadened, we need to be more comprehensive in our thinking, policy prescriptions and communications. We need to see the bigger picture on trade, as one part of the larger economic and political context in which it operates. Trade policy should be understood and communicated to the public as being about more than negotiating trade and investment deals. Increasingly trade policy discussions need to include, as a central focus and not an afterthought, a complementary package of domestic policies to help our firms and workers take advantage of new opportunities abroad and adjust to global developments.

This calls, of course, for a whole-of-government approach to align seemingly disparate policy efforts and to ensure coherence among interrelated areas. Adopting a big-picture trade strategy and narrative is how governments can offer the type of “grand bargain” that’s now required to maintain public support for trade in advanced economies.

To give one example, this would mean emphasizing the inherent complementarity between promoting trade and developing the skills of our workers (particularly portable skills that lower labour market adjustment costs). While it’s easier said than done, governments need active labour market policies that will help workers prepare for and land their next job at thriving, innovative companies that are engaged internationally, rather than trying to protect jobs that have been rendered obsolete, by shielding them from the rest of the world.

The overarching goal should be to make trade policy more inclusive. A key take-away from recent trade criticisms is that promoting productivity, while obviously important, isn’t enough. We can’t ignore adjustment costs for displaced workers and simply assume that net benefits will be widely distributed. Indeed, who benefits from economic developments and policies has become a first-order concern. That’s why there’s growing support internationally for a more inclusive approach to the overall economy, including trade, at institutions like the OECD, IMF, World Trade Organization, and the World Bank. When Canada chairs the G7 meetings next year, we should champion a concerted push to widely adopt more inclusive growth policies — of which a key component should be a more inclusive trade agenda.

This approach should be described in a nuanced and realistic way. International trade is certainly a potent tool to encourage economic growth, particularly now that growth has slowed. Trade has also improved the global distribution of income, by supporting strong income gains and reducing extreme poverty in developing countries. Moreover, trade has increased purchasing power for consumers, particularly lower-income households in advanced economies who spend more of their income on tradeable goods. As such, there’s no doubt that trade has many promising features that fit with the Liberal government’s desire for a “progressive trade agenda.”

But that’s not the whole story. On the production side in advanced economies, it’s not obvious that further trade integration will necessarily be more advantageous, say, for workers who mainly perform routine tasks that can increasingly be automated or offshored, than for our highest-skilled workers, senior executives and business owners. As we have long understood, there will be winners and losers. Nascent research is emerging (for example, see here) that will eventually provide a better sense of trade’s distributional impacts on the Canadian economy, for its businesses, its workers and its consumers. Over time we need to develop a stronger evidence base to inform policy-making, but in the meantime there’s much we can do.

Governments would be wise to avoid overstating claims about what trade can deliver. Promising “progressive” trade, if that means larger net benefits to those lower down the income distribution in Canada, is likely promising too much. Instead, they should be talking about making trade more inclusive than it has been, and taking steps to demonstrate incremental progress in this regard. A key part of a more inclusive trade agenda should be implementing policies that will make trade opportunities more accessible, though not necessarily making trade outcomes more equitable.

Put differently, trade policy needs to focus more on a “predistribution” approach, making trade accessible to more participants, rather than pursuing business as usual and relying on “redistribution” to partially offset market inequalities after they’ve occurred. More work should be done before we design new trade support programs or sign new trade deals, and to follow up better afterwards to track whether new participants have taken advantage of the opportunities created.

Due to the large fixed costs of exporting, we know that merchandise trade revenue is highly concentrated among a relatively small number of very large exporters (figure 5). Such large imbalances put a premium on finding ways to enable new traders to enter international markets and scale up.

 

A major task, therefore, should be building more “on-ramps” to the global trading system that are focused on assisting those who previously haven’t been major players: small and medium-sized enterprises (SMEs), women entrepreneurs, emerging economies, and remote regions of our vast country beyond traditional trading corridors.

These groups face various obstacles that aren’t easily overcome: limited information, financing and networks; high entry costs, especially for first-timers; difficulties navigating inconsistent regulations across countries; underrepresentation in decision-making and rule design; entrenched interests that benefit from the status quo; and geography.

Broadening trade participation will require resources and sustained effort. Two areas are particularly promising. Although not a panacea, technology has the potential to make information easier to find and to enable prospective traders to participate internationally and reach farther. Indeed, while trade traditionally has been dominated by large multinationals, online trade features more new exporters, including small firms, that can reach many countries, and revenues that are less concentrated among the biggest firms. The second related area where we should look to expand opportunities is for Canada’s service providers. Service industries typically have much lower entry costs than for goods producers — in some cases the essential elements are an idea, a business plan, a computer and an Internet connection.

Ultimately, the appropriate response from policy-makers in advanced economies to recent trade criticism is multifaceted. Beyond simply acknowledging these concerns, they need to study the impacts of trade along the income distribution. They need to construct more comprehensive trade policy agendas and communicate them more effectively. These agendas need to go well beyond trade negotiations and emphasize the links to domestic policies. This is how to get at the root causes of broader contemporary economic anxieties swirling around such issues as inequality, limited intergenerational mobility and problems with labour market inclusion.

Canada has avoided the more extreme populism seen in the US and the UK, but we still must be proactive and demonstrate progress toward making trade opportunities more inclusive, and spreading the benefits of globalization and technology more broadly. Increasing trade participation can maintain public support in Canada for further trade integration, and this can be a key component of broader efforts to deliver more inclusive economic growth.

This article is part of the Trade Policy for Uncertain Times special feature.

Photo: People fill the street outside Canada Place during Canada Day celebrations in Vancouver, B.C., on Saturday, July 1, 2017. THE CANADIAN PRESS/Darryl Dyck


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