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Who's Bashing Whom? Trade Conflict in High-Technology Industries.

Until recently, there was probably more agreement among economists on the desirability of free trade than on any other economic policy prescription. The case for reliance on comparative advantage was well buttressed by theory: a Pareto optimum is achieved when the international marginal rate of transformation equals the domestic marginal rate of transformation. This would happen in a competitive environment under free trade for a country; in the absence of monopoly power in trade, protection would unequivocally reduce welfare.

With the advent of the "new" trade theory, in which monopolistically competitive or oligopolistic industrial organization could lead to a divergence between marginal cost and price, however, the theoretical underpinnings of the free trade prescription appeared to weaken. Simultaneously, popular pressures have arisen for trade interventions, including especially "managed trade". Laura Tyson has been a highly visible proponent of managed trade, which she defines as being "commonly understood to encompass any trade agreement that establishes quantitative targets on trade flows. Managed trade thus lies at one end of a continuum between regulating trade flows through fixed rules and regulating them through fixed quantities or targets". Tyson advocates managed trade in "high-tech" industries, arguing that laissez-faire and free trade subject to international rules of the game will not secure as favorable an outcome for the United States.

Tyson's most recent book was of interest when it appeared as the latest, and therefore presumably the most carefully articulated, statement of her position. Given her appointment to chair the Council of Economic Advisers, interest increased. The book should be read and taken seriously by all economists.

Unfortunately, it is an exceptionally difficult book to review; the central message is not well focussed. Chapters 1 and 2 present a broad overview of high-technology trade and the issues as perceived by Tyson; Chapters 3 through 6 provide case studies of individual industries; Chapter 7 then provides a conclusion, yet even there, there is no systematic answer to the question as to why "quantitative targets" rather than alternative instruments of policy are appropriate for intervention. Indeed, in much of the book, Tyson claims that she is advocating "civilian industrial policy", on the grounds that trade policy is an inadequate tool.

A first question that arises for any economist in assessing the book must be what it is about high technology industries that is believed to warrant special treatment and managed trade. This is addressed in the first chapter. Tyson's defense is: "The composition of our production and trade does influence our economic well-being. Technology-intensive industries, in particular, make special contributions to the long-term health of the American economy. A dollar's worth of shoes may have the same effect on the trade balance as a dollar's worth of computers. But . . . the two do not have the same effect on employment, wages, labor skills, productivity, and research--all major determinants of our long-term economic health. In addition, because technology-intensive industries finance a disproportionate share of the nation's R&D spending, there is a strong presumption . . . that they generate positive externalities for the rest of the economy". Tyson there and elsewhere appears to equate managed trade with pro-active support for high-tech industries which would under all circumstances be preferable to a market outcome. Elsewhere she asserts that managed trade is "second-best", justified only because other countries intervene. These are not the same argument, and there is some confusion in the reader's mind throughout the book as to which Tyson advocates.

At any event, Tyson's argument is not compelling. First, it is not evident why impact on the trade balance, employment, or research should be a desideratum of trade policy. The trade and current account balance are functions of macroeconomic variables including monetary and fiscal policy, and not the composition of exports. As to employment, once again, the level is certainly understood to be a macroeconomic variable and a function of the real wage relative to levels of productivity. Further, even when consideration is given to R&D spending, its positive impact clearly hinges upon its allocation to activities with a high payoff: R&D for its own sake is no more valuable than any other make-work activity, and, to the extent that it pulls talented scientists and engineers away from other more valuable activities would constitute a misallocation of resources unless the product is high enough.

Confronted with these arguments, Tyson would no doubt rejoin that "history matters" and that comparative advantage may depend on it. Yet, as her case studies clearly show, history matters positively and negatively. First comers are not always successful (Trident, turboprops and American automobiles are examples) and the histories she cites provide no clue. The argument is not used in Tyson's later appeal for industrial policy. Nor is the possibility that more and better training of scientists and engineers may be the most effective "industrial policy" even addressed. If there are many scientists and engineers whose compensation is lower than that in other countries, surely there will be comparative advantage in industries using them intensively?

Having made her introductory statement, the reader anticipates that Tyson's case studies will amply document her claims. Alas, they do not. They are "case studies" in the sense that they are good histories of the course of events in particular industries. In no sense do they provide compelling, or even persuasive, evidence for Tyson's proposition. Indeed, in several chapters, the reader comes to the end, anticipating that Tyson will elaborate on the relevance for policy, only to be disappointed with sweeping conclusions that do not appear to follow from what preceded them.

The underlying problem is the lack of an analytical framework for evaluation of the histories. Space limitations preclude more than an illustration. Tyson's Chapter 5, providing a history and evaluation of intervention in the aircraft industry, is perhaps the most obvious. She traces "mistakes" of governments and of firms in an industry which she believes is naturally concentrated because "the enormous cost and forbidding risk of new product launches crucially affect market conduct and performance". She notes that European subsidies to Airbus provided more competition (good) and cheaper aircraft to the airline industry than would otherwise have occurred (good), and recognizes that "it is impossible to conclude that the overall welfare effects of such subsidies have been positive. But there should be no presumption that they have been negative either".

The reader is left puzzled, given that and similar conclusions, as to what Tyson is advocating. On one hand, she points to mistakes of individual aircraft producing companies. On the other, she points to mistakes of governments. She does not appear to have a theory of economic policy determination (although she bemoans the influence of large firms on policy--see p. 215). She discusses industrial policy as being capable of being "effective . . . without necessarily being welfare-enhancing", and yet concludes that knowledge of the details of the aircraft industry are essential for making policy. On reading of the complexity, risk and uncertainty, this reader concluded that those making decisions about new aircraft types should surely bear responsibility for those risks: not an activity in which governmental decision-making mechanisms have a comparative advantage. Tyson traces the failure of turbo-props, yet suggests no mechanism by which taxpayers might be assured that the visible hand of government would not support similar ventures in the future. Interestingly, Concorde is mentioned only once, and then in connection with the competitive response it stimulated.

When it comes to setting quantitative targets (the initial definition of managed trade), many obvious questions arise. Surely it cannot be expected that governments in market-oriented economies are going to set physical controls requiring firms to purchase particular goods. If not, one wonders what the rationale for quantitative targets is, how they would be determined and administered, and how third-country effects would be taken into account. But these questions are not addressed in the Tyson manuscript.

There are other problems (such as a considerable amount of highly inflammatory language vis-a-vis Japanese behavior--see pp. 138 and 146 for examples), although they are secondary to the fundamental issue: the book lacks a convincing analytical framework, and does not describe a decision-making process within government that would lead to outcomes superior to laissez-faire. Absent that framework, the reader cannot contrast the welfare consequences of laissez-faire and the mistakes that firms make relative to the consequences of governmental intervention with the mistakes that bureaucrats make. The argument that government might fail even worse than the market is not taken seriously; Tyson simply argues that the government should do better.

The infant industry argument, while obviously correct in theory when appropriate externalities and dynamic effects are assumed, has been badly misused in practice; in large part, this was due to the inability to associate theory with ex ante empirically identifiable conditions. The argument for "managed trade", or industrial policy, as set forth by Tyson might be made analytically airtight along the lines of strategic trade theory. The difficulty, one fears, arises because ex ante empirical identification of the conditions under which the argument is valid would not be feasible and because governmental decision-making is not undertaken by benevolent social guardians immune from political pressures.
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Author:Krueger, Anne O.
Publication:Southern Economic Journal
Article Type:Book Review
Date:Oct 1, 1993
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