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The New Case for Trade: Expanding Competition, Innovation and Growth

Posted April 15, 2015

In addition to the outreach made by key cabinet officials last week, Jason Furman, one of President Obama’s top economic advisers made an elaborate pitch to the influential Brooking Institution for how expanded trade in a globalized world can benefit the middle-class by increasing innovation and, therefore, economic growth.

“Trade has many advantages. In the 2015 Economic Report of the President, we described a number of others besides increased productivity growth, including trade’s role in reducing global poverty, improving working conditions in the developing world, promoting gender equality, and increasing investments in green technologies to reduce global greenhouse gas emissions,” Furman told the Washington think tank.

“But ultimately, and most importantly, trade is an important driver of long-run economic growth. Enacting high-standard and values-driven trade agreements is a significant plus – and even more so when they are part of a broader economic agenda to expand public and private investment in America’s workers, businesses and infrastructure.”

Furman outlined two ways in which trade can increase total factor productivity, both as a direct input into the innovation production function and as an increased incentive to innovate. If innovation is thought of as being the outcome combining inputs like research and development (R&D), Furman said, then trade can increase the amount of knowledge produced per unit of R&D investment if companies in different countries focus on innovating in the areas where they have a comparative advantage. For example, if engineers at Toshiba focus on improving memory chips, and engineers at Intel focus on improving microprocessors, the R&D productivity of each firm may be higher, leading to better and cheaper computers than if each company had to improve both components simultaneously. 

“Trade also helps firms become more productive by accelerating the global flow of ideas,” according to Furman. “Both exporters and importers are frequently exposed to new ideas and novel tools, materials, or techniques that make them more productive.” Two examples of this phenomenon cited were that of multinational companies which promote the diffusion of more efficient “best practices” within their global supply chains and the substantial productivity benefits realized by many American manufacturers and other industries from adopting aspects of the “lean” production system, which was originally developed in Japan.

Similarly, Furman alluded to the “learning-by-exporting” theory, which maintains that a company’s performance and productivity improves after entering export markets, not only by gaining technical expertise from the process, but also by spurring them to become more competitive.

Turning to the challenges of expanded trade and most particularly the downsides to globalization, Furman acknowledged that growing economic integration around the world had played a role in the increase in inequality, although he said “most economists would rank it below factors like technology, education, and labor market institutions.” He likewise downplayed the correlation between globalization and increased turnover and dislocation, stating that it represented only a small fraction of that which is to be expected in any given month and that, in fact, much of the turnover generated by trade was actually realized in a shift to more “high quality” jobs.

Nonetheless, Furman indicated that these challenges merit a serious policy response, part of which involves accepting that many of the downsides of globalization actually stem from factors outside of trade policy – factors such as improvements in transportation and information technologies which have driven the recent rise in world trade. Looked at from this vantage, the importance of “next generation” trade deals such as TPP is to ensure that the United States is “managing the process of globalization” by, for example, incorporating stronger labour and environmental standards than would otherwise be the case without such agreements.

The other aspect to consider in this regard is that of “complementary policies” such as investment in infrastructure, research and education as well as reforms to the business tax system, all of which can provide a greater return in an environment of global integration by expanding the size of markets, attracting more foreign investment and providing better employment opportunities of the kind associated with export-intensive industries.

Click here to download a transcript of the speech.