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One of the key lessons from the 2008 global financial crisis was that financial models don’t always work. The idea that one could throw thousands of variables into an algorithmic black box, match them with the millions of positions that banks take every day, and derive a simple and easy-to-understand assessment of potential balance sheet losses or gains is now seen as naive. Risk can ricochet in ways we cannot begin to model mathematically, and market events often create their own dynamics.

Likewise, since the Covid-19 pandemic and the war in Ukraine, there has been a rethinking of overly simplistic notions of shareholder “value.” We have moved beyond the era in which corporate leaders were only expected to raise stock prices and lower consumer prices.

We now understand that stakeholders – from workers to communities to the public sector – also need to be served. We see that “negative externalities” such as environmental degradation or low labor standards have their own costs. This has led to a much deeper discussion about the true price of “cheap” goods and services.

But these kinds of insights have not yet largely impacted (no pun intended) our thinking about global trade. Any questioning of free trade is still seen as a defense of protectionism. Tariffs are always bad.

Yet we rarely think about the assumptions of the models we have relied on for decades to arrive at these supposed truths. This is despite the fact that the events of the last 20 years are increasingly challenging our fundamental preconceptions about how countries do or do not trade.

In this regard, we must consider everything from the rise of state capitalism and mercantilist China, to the successful use of industrial policy by the East Asian “Tiger” countries, to the fact that most trade agreements signed in the last 30 years have been for less about removing cross-border restrictions rather than negotiating standards for workers, the environment, intellectual property, etc.

In such negotiations, multinational corporations had an enormous advantage over individual nation states and the workers within them. As Indian politician Rahul Gandhi recently put it, the West “created” modern China as the world’s factory, as multinational corporations in the United States and Europe preferred its “coercive” production model to those of other nations. Capital thrived by outsourcing production worldwide, while workers in places with hollowed labor markets or polluted environments did not.

These asymmetries are now prompting closer scrutiny of the models that policymakers have traditionally used to garner support for free trade agreements. For example, consider the general equilibrium models that economists use to analyze the effects of trade reforms. They contain Panglossian assumptions about “full employment” and “free change,” whereby, for example, a laid-off autoworker in Detroit can simply walk across the street and find a new job for the same wage.

Such models also do not take into account the tendency of capital to seek places with the lowest costs of production or the broader economic and social impacts of the hollowing out of communities. Nor do they consider the benefits of growth through production rather than consumption, or the longer-term impact of stable jobs and capital stocks on communities. The result is that the models tend to downplay the costs of free trade and, at least according to some analysts, overstate the costs of tariffs.

In 2021, a group of Democratic senators complained to the US International Trade Commission about the assumptions and omissions in a report on the “small but positive impacts of various trade agreements on the US economy” since 1984. A few years earlier, in 2018, a A report from the Federal Reserve Bank of Minneapolis found that standard trade modeling failed to capture the real effects of four recent bilateral trade liberalizations. In fact, researchers at the Minneapolis Fed found that the model in question (the Global Trade Analysis Project model, or GTAP) had “essentially no predictive accuracy.”

Scientists and trade associations are now experimenting with tweaking traditional trading assumptions. The Coalition for a Prosperous America, a nonpartisan trade group representing domestic producers and workers in the U.S., recently modeled what would happen if the U.S. imposed 35 percent tariffs on all manufactured goods from countries without a free trade agreement with the U.S. (including China). would impose 15 percent tariffs on all non-manufactured goods. It also assumed “tariff productivity elasticities,” meaning that growth could come from production rather than just cheap prices, and “factor supply elasticities,” meaning that levels of employment and the capital stock could rise.

The result was that gross domestic product increased by $1.7 trillion, 7.3 million new jobs were created, and real household incomes increased by 17.6 percent. Of course, this model did not take into account the geopolitical consequences of such an action – just as traditional models did not take into account the populism fueled by global trade paradigms that were ahead of national politics. The point is simply that the assumptions we make matter when we think about trading.

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