It's obvious that nations are places, right? But somehow that fact is lost in much of the debate over trade and immigration. Instead, the argument usually goes something like this: Trade and immigration help some people and hurt others, though gains should exceed losses in the aggregate. How do we weigh benefits to winners against harms to losers?

But trade and immigration policy don't just affect people. They affect places. Why should that matter? Places experience neither pleasure nor pain. Places do not love. If you prick them, they do not bleed. Isn't it right that economists ignore places, and focus on how policy affects human beings?

No, it is not right. It is dangerously obtuse. You will often hear economists laud the indirect benefits of market economies. Where markets flourish, virtues such as tolerance, diligence, entrepreneurialism, and creativity thrive as well. Markets depend upon trust, and market-based societies tend to develop unusually strong habits of trust between unrelated strangers, as well as institutions for punishing violations of good faith impartially. Where there are markets, there is industry, human capacities are exercised, and profitable collaborations are encouraged. Markets promote wealth, and affluence leads to beautiful private spaces, and then beautiful neighborhoods and vibrant cities for all. Markets create incentives for human beings to improve themselves even more than their homes, filling the world with interesting, passionate, talented people.

These indirect effects of economic activity amount to what I'll call "emergent public goods". These are distinct from (but complementary to) traditional public goods, like roads and parks, that governments explicitly purchase. But here's the thing: In successful nations, access to emergent public goods is the single greatest asset most citizens have. Why would so many people from broken countries give up whatever wealth they've accumulated to live in the United States or Western Europe? Because access to the public goods on offer in those places is worth more than all that they own, and more than the awfulness of having to start over in a strange place, confused, mute, and alien. Even when direct public goods are withheld (for example, from illegal immigrants), emergent goods flow like air to everyone, simply by virtue of where they are. "Opportunity", the fudge by which economists turn the pain immigrants endure into net-present-value enhancing rationality, is nothing more than an emergent public good. And opportunity, like other emergent public goods, is attached to place.

I am (very reluctantly) trade-skeptical at the moment, and not because I think that the United States' present aggregate losses are larger than its gains from trade. On the contrary, I wish to see Americans' current debt-for-goods trade stop despite any aggregate gains, because I think that this trade pattern is undermining America's capacity to sustain and enlarge its portfolio of public goods. It is not that unbalanced trade is hurting people (although of course it is hurting some and helping others). Unbalanced trade is hurting the place, and the place, the privilege of living in this extraordinary country, is the most important asset Americans have, however long they've lived here.

Trade in services (i.e. outsourcing) and immigration have broadly similar distributional effects. There is little economic difference between a programmer in India writing code very cheaply and the same individual coming to the United States and doing the work for less than the local prevailing wage. Nevertheless, I'm inclined to favor the immigration, but not the trade, under present circumstances. Why? Because when a worker immigrates, the productive economic activity happens here, in this place, and that is oxygen to America's portfolio of public goods. When Americans trade debt for services performed overseas, the good side effects of human industry happen somewhere else, and the bad side effects of accumulating debt happen here. It's all the same to the people. But unbalanced trade hurts the place.

Nations are places. Quality of place is incredibly valuable, and potentially fragile. Any consideration of trade or immigration that tallies up gains and harms to people is incomplete if it fails to take into account how different economic arrangements affect the quality of places.

Here's Dani Rodrik on export subsidies:

[T]he economic case for countervailing duties is extremely weak. (The standard economist's line is that you should respond to other countries' export subsidies by sending them a thank-you note, not by shooting yourself in the foot in return.) But presumably there is some (second-best or political) reason why WTO rules sanction countervailing against subsidies.

This paragraph struck me as delightfully odd. Two facts that don't get along are stuck together and left to eye one another warily:

1. Export subsidies are so widely perceived as harmful to recipient nations that the World Trade Organization, a body whose "overriding purpose is to help trade flow as freely as possible", countenances trade barriers to combat them.
2. Standard economics suggests that an export subsidy represents a windfall to recipient nations, an opportunity and a boon, not a harm at all.

What gives? In the wide and wonderful field of economics, is there no room at all for the commonplace observation that a subsidy often does harm to its recipient?

In everyday life, we know that in order to do more good than harm with a subsidy, we often need to make predictions about how the recipient will respond to the grant. Offering to cover an 18-year-old's college tuition is very different than cutting a no-strings-attached check, even if the money's the same either way. Some 18-year-olds would be better off with the cash than a paternalistic tuition grant. But most probably would not be.

This sort of analysis is a priori out of bounds to any economics that views people as rational maximizers. If the best thing a teenager could do with a couple hundred thousand dollars is to turn it into a four-year annuity for college, the utility maximizing teenager will do that. If she chooses to do something else, by revealed preference, that must be the better choice. Right? No.

We reject this kind of reasoning in real-life, even when considering fully competent adults. If we can understand why it is not nice to put a slice of apple pie on a struggling dieter's plate, or why very low introductory "teaser rates" on a home mortgage can entice borrowers into dangerous situations, why can't we understand that certain kinds of subsidies increase the likelihood an economy will trade short-term gains for long-term harms? Of course we do understand that, even the WTO understands it, but economics as a discipline has a remarkably hard time coming to terms with the intuition. Human choice is endogenous and stochastic, not exogenous and rationally determined.

There's an important distinction between noting that certain subsidies increase the likelihood of bad outcomes for a recipient and suggesting that the provider of a subsidy is therefore culpable for the outcomes. It's usually counterproductive to blame someone else's generosity for ones own poor decisions, even if the generosity was cynical and the bad consequences were anticipated by the donor. A crucial feature of subsidy is that it may be refused. A dieter may prefer not to be tempted by the sights and smells of heaven à la mode. But if a host insists on offering, she should still refuse the pie. At the national level, things are more complicated. An export subsidy likely to cause long-term harm to a nation may unambiguously benefit some individuals. How does a nation "refuse the pie"?

By enacting countervailing import tariffs, according the the WTO. But that seems like poor table manners, like raising a middle finger when a simple "No, thank you" would do. If only they could get over the logic of "might as well eat", economists would have little trouble devising polite but firm ways of saying no.

We'd still miss the pie. But maybe that's for the best.

Tyler Cowen invokes a case frequently made (among Americans) in favor of free trade:

...I am still waiting for someone to defend trade barriers across the 50 states.

It's important to note that even among the 50 states, textbook "free trade" does not exist. There are no tariffs, but the United States is riddled with internal "export subsidies". When a state or locality puts together a deal to attract a factory, retain a corporate headquarters, or support a local industry, what is that about? Those tax breaks, underpriced loans, and infrastructure buildouts are explicit subsidies whose purpose is to ensure some economic activity happens "here rather than there", for reasons that elude sterile Econ 101 models of trade. They are usually granted to firms or industries that produce for markets much larger than the subsidizing locality, and, as with export subsidies, the benefits are shared by far-flung shareholders, managers, and customers, while the direct costs are borne locally by taxpayers. Yet they are still popular. States worry openly and realistically that they may lose industries without competitive incentive packages. The usual justifications for these programs precisely match the arguments for export subsidies — jobs (first and always), fighting poverty and blight, creating "clusters" ("Silicon"-everywhere in the late 1990s), and defending against depredation by other localities. Lots of governors, mayors, state legislators, and city councilman routinely defend these trade barriers across the 50 states.

Using the United States, plural, as a standard-bearer for "free trade" argues for a world with few tariffs, but a whole lot of strategic government subsidy. That might be a good model, actually, but it is not the model free trade ideologues usually have in mind.

I've been hung up (unfortunately not hung over) for the last few days, and I've pent up a list of short comments I can't wait to get of my chest. Here's the first one...

William Polley understands that what happens between the 50 United States deviates significantly from an economists ideal of free trade, and that economists who wish to argue for international free trade by virtue of an American success story need to deal with this fact. Polley writes:

...Here in the U.S., the framers of the constitution were smart enough to establish the fledgling country as a customs union and monetary union. This was in order to form a more perfect political union that that Articles of Confederation was unable to deliver.

Unfortunately, this does not stop the states and localities from pursuing other policies (wooing multinational factories, establishing tax-increment financing districts, etc.) that do with a series of knife cuts a bit of what a tariff would do with a hatchet blow.

...Tennessee would not do itself any favors by unilaterally abstaining from offering incentives to companies to locate there. But reducing state level competition of that sort would benefit everyone.

I'm not sure I agree with that last point. States and localities may well gain from the deals they make to encourage development. Overall gains attributed by economists to "undistorted" free trade still involve winners and losers, and it is perfectly rational for localities likely to lose (and unlikely, in the usual dodge, to be "compensated by winners") to try to change the game. Taking Don Boudreaux's original point to heart, I do think the sausage factory of trade among the 50 US states has worked reasonably well. So rather than arguing from a model that the system of subsidy-by-locality should be dismantled, I'm inclined to keep an open mind about whether politicians responsible for quality of place might not know something missed by economists, whose models often lack recognizable notions of place entirely.

If Canada is divisible, then Quebec is divisible. If Quebec is divisible, then Montreal is divisible.

Gabriel Mihalache tries to pull the old reducto ad absurdam on my contention that nations are places, and the implication that quality-of-place considerations might lead to deviations from the traditional case for free trade. He writes:

Why not ask… if localities can benefit from these deals, this industrial policy—to quote another skeptic—then why not apply the same idea to streets, town squares, and beyond? — Maybe we should have a sort of street prefect, with his own budget, ready to subsidize business start-ups on his street?

Why allow for free movement between 1^st Avenue and 5^th Avenue? Maybe 1^st Avenue could benefit from some regulation or from offering subsidies? Why not?

To which I answer enthusiastically, "why not indeed!" Shopping malls are places too. Shopping mall developers often want big-name retailers as "anchor stores", so they offer national chains great deals on rent, and sometimes sweeten the deal with cash. This might seem economically foolish, at first glance. But the subsidy turns out to be small compared with the increased certainty that the mall will attract customers, and the higher rents boutiques will pay to sit between popular behemoths.

Malls are hardly a unique example. Most commercial real-estate owners will offer discounts to tenants they consider particularly "desirable", whose presence will in some hard-to-pin way increases the value of the property they have on offer.

People who live who live on nice streets often spend a great deal of money to maintain the exteriors of their homes, the quality of their lawns and gardens, etc. Part of this one can chalk-up to "consumption" — people take pleasure in having a nice spaces. But a lot of this represents a kind of informally coordinated public investment, enforced by social norms. The value of properties is contingent in part on the niceness of the street, and everyone is expected to do their part. Some neighborhoods are developed as mini nanny states, with coercive regulations one must adhere to as a homeowner in order to ensure that residents don't shirk in maintaining (often uninspiring) "standards". Neighborhoods organized as condominiums have the power to tax and spend to maintain and enhance the quality of space. Lots of people are pleased to submit to all this. (I don't necessarily endorse these neighborhoods. The uptight, snooty ones make me go "ew". But hey, it's the free market in action!)

Gabriel:

Maybe, but exactly like free trade, these deals have winners and losers (who, just as with free trade, won't get compensated). Also, there's the issue of the “relevant moral community”. (Do poor Chinese children enter into your welfare judgments?… and the like.)

Basically, this boils down to choosing between two patterns of winners and losers, which is a political choice. You can show, maybe, that with an utilitarian “social welfare” function, the “development deal” is preferable. But that's a big “maybe”. And it's still politics, so it's not a matter of knowing something that the economists don't.

I won't argue much with this, except to note that, just as with free trade, enhancements of place may create winners and losers, but large overall gains. Many shopping malls could not survive without subsidized anchors. Boutique owners might be unhappy to subsidize the rent of retailers with much deeper pockets than themselves, and some potential renters might be so pissed off they refuse to rent. Still, it's hard to argue that there isn't a large overall gain from the subsidy.

A condominium association might decide that common spaces need to be repainted annually, and fees will be increased to cover the expense. Some homeowners undoubtedly will consider the fresher halls to be worth less than the money they pay out. Given heterogenous and uncertain utility functions, one objector's sheer misery might be enough to outweigh any gains to other tenants. But, under ordinary assumptions, if the vast majority enthusiastically support the change, we usually presume overall gains. The case for overall gains is at least as clear as in the argument for free trade.

Of course, if leadership of the condominium association has been hijacked by unrepresentative busy-bodies, or by a board member whose kid brother is a painter, large overall losses might result. But the possibility of agency problems oughtn't prevent us from considering potentially welfare-enhancing subsidies. Both action and inaction are potentially flawed choices. In the real world, we do our best to control agency costs, but we still make decisions.

I do want to emphasize that I am playing with ideas here, and not quite endorsing the idea of legitimizing state subsidy as a normal part of international trade. It's a surprisingly interesting idea, and one can make the case for it in very "orthodox" terms. (If one does so, one finds that what is destructive of overall welfare is to abstain from subsidizing!) But the agency problems are, to say the least, daunting.

Regardless, people like Don Boudreaux who want to argue for traditional free trade based on the example of trade within the United States need to grapple with the historical fact of ubiquitous subsidy. And I'm not just playing when I suggest that any model of trade that looks only at gains and losses to individuals without considering quality of place is simply inadequate as a basis for policy.

A nice sentiment, surely. But is it good economics? My takeaway from China's experience is that it is, or it can be. There are lots of ways to spin China's policy of limiting the appreciation of its currency in order to promote export-led capital formation and growth. One story is simply that the policy amounted to a export subsidy: Purchasing power was withdrawn from Chinese workers and transferred to dollar and euro spending foreign consumers.

It's unmistakable that the policy "worked", in some sense. China's growth, along with the scale and pace of change in that country, have been remarkable.

I've mulled over the question of subsidy before. Simple economic reasoning suggests that subsidies harm the subsidizers and help the subsidizees. Yet nations often do subsidize their exports, overtly and covertly. Instead of welcoming cheap goods with open arms, the recipients of the subsidized merchandise usually complain, and sometimes slap on "anti-dumping" tariffs to keep cheap goods from being too cheap. Economists often tsk-tsk at all this, blaming both the subsidies and the tariffs on rent-seeking politically connected manufacturers. It's all "protectionism", they say.

A fair review of the history of "protectionism" would be much more mixed than the economic mainstream would like us to believe, with their stories of comparative advantage and expanding production possibility frontiers. (Thankfully, economists like Dani Rodrik and Paul Krugman weave more nuanced tales, but still "protectionism" rates somewhere just below coprophagia on the economic profession's list of distasteful things.) In some times and places, trade barriers have served to isolate and impoverish people. In other times and places, tariffs have protected infant industries that grew into powerhouses in countries (like the United States) that otherwise might have remained agricultural backwaters. That said, I think we should avoid tariffs, not in deference to economic pseudoscience, but because they are stultifying. Intercourse across borders is a per se good. A mixed-up, intermingling world is better than one made up of insulated national tribes. We should avoid tariffs not because of their adverse economic consequences, but despite their potential economic benefits.

But subsidy is a different story. Export subsidies do not diminish international commerce, they, um, subsidize it. From a libertarian perspective, there is a strong case against tariffs. Trade restrictions prevent free people across borders from interacting as they wish. But subsidies restrict no one. Sure, libertarians might complain of the wealth expropriated to fund the subsidy, but that critique applies to nearly all functions of modern government. Until we abolish public schools and the NIH, there's no reason we shouldn't have export subsidies.

The more serious case against subsidies is that they are "distortionary". But for even the most ham-handed sort of subsidies, where governments favor particular firms or industries, it is not at all clear that this is so. Investment is not a "distortion", even though it involves accepting an up-front cost. When local governments offer tax abatements, free infrastructure, and other perqs to attract economic activity, there's a clear payoff from taxpayers to particular private parties. Yet sometimes these inducements do pay for themselves, in financial terms as growth increases the long-term tax base by more than the upfront costs, and in nonfinancial terms as residents reap direct and indirect benefits from prosperity of place. Sure, governments make poor investments sometimes, whether corruptly or out of innocent miscalculation. Firm managers also make bad investments, and sometimes their motivations in doing so are not aligned with the welfare of shareholders. Sometimes firms are large, and capable of investing on a scale that deters potentially superior upstarts from entering a market. But we don't prohibit corporate investment as "distortionary". In both the public and private sector, restricting investment implies preventing potentially welfare-enhancing projects from taking root. Subsidies, when they are not a form of corruption, are a form of investment. We should be very careful in designing public subsidies to private parties, since the potential for crooked dealing is obvious. But forbidding subsidy outright is prima facie welfare destructive. Preventing governments from internalizing the external benefits their communities would receive from economic development would itself be "distortionary". (I dislike the language of optimality and distortion favored by economists. But when in Rome...)

The example of the United States is often held up as a model of a free-trade zone, as a reducto ad absurdiam. If protectionism is such a good idea, asks some supercilious hypothetical interlocutor, why shouldn't we have tariffs between Tennessee and Alabama? Of course we don't, and shouldn't. But Tennessee and Alabama can and do compete in bidding wars with firms deciding where they ought to put their factories. The "free trade" that has worked so well among the 50 United States is actually a trade regime involving ubiquitous and competitive subsidies. Maybe that's not a flaw, but a feature.

At this moment, there's a fear that "Smoot-Hawley", "beggar-thy-neighbor" protectionism will take hold, condemning us to a depression more harmful than the one we already face. If insufficient aggregate demand is the problem, then competitive tariffs are a negative sum game: They not only confine demand within borders, but they eliminate demand that would otherwise exist for goods and services that could be provided internationally. So, the fear of tariffs is not misplaced.

But competitive export subsidies are a different thing entirely. If the people from whom funds are borrowed or taxed would otherwise have saved, then export subsidies can increase effective aggregate demand. A trade war in which the nations of the world strive to outgive one another in order to help support their own industries would amount to a collaborative global stimulus. Angloamerican economists are tut-tutting over how "surplus countries" aren't doing their part in stimulating domestic consumption. Instead, export-heavy nations are stimulating consumption elsewhere, by stepping up their export subsidies. If China wants to support American consumption, then why shouldn't America support Chinese consumption? Rather than digging holes again and filling them back in again, why not give the world's "bottom billion" perishable gift cards redeemable for US goods and services, and let the jobs follow?

I don't think this is only a matter of "depression economics". It really is better to give than to receive, even in good times. But it is impolite to give but then refuse the gifts of others. And it is best to be up front about what you are doing. Making "loans" that are unlikely to be repaid is the worst form of giving. Everyone ends up unhappy when the inevitable comes to pass.

I started with the example of China, and I'll end with it. A year or two ago, China looked unstoppable, but suddenly conventional wisdom is that chickens are coming home to roost. China has subsidized exports, but its subsidy has been synthetic, implicit and deniable, and therein lies its problem. As Brad Setser has described for years, in order to maintain a "crawling" currency peg, China's central bank has been forced to purchase US dollar assets on which it must expect an eventual loss in real terms. China's subsidy to foreign consumers has been hidden in this overpayment. China's policy of giving worked very well for it, but executing that policy by pretending to lend rather than to give has put the nation in a bind. The technocrats responsible for China's huge currency reserves must continually expand their losses by purchasing more dollars to keep the value of the dollar high and hide the costs of subsidies already granted. If they do not, the exposure of large financial losses might create a firestorm of domestic outrage. China's central bank might be able to hide reserve losses by engineering a large domestic inflation, so that its US dollar portfolio does not lose value in nominal terms. In either case, even though the development gains were almost certainly worth the financial cost of China's export support, China's leaders face a problem since they pretended there was no subsidy when in fact the subsidy was very large.

It would have been better for China as well as for its trade partners (who face traumatic currency devaluations) if its policies had involved explicit, sustainable, and broad-based subsidies to foreign consumers. Explicit subsidies paid over time are more politically palatable than sharp losses suddenly revealed. China's covert, financial-engineered subsidies relied upon complex chains of financial intermediation, which eventually could not withstand the stress. China is still trying to subsidize, but lending to the US Treasury no longer translates to increased consumption by American consumers. China's approach to subsidy contributed to instability in the financial arrangements of its customers, which has unsurprisingly boomeranged, creating economic instability in China.

Here is my proposal for the WTO. I know it will be greeted enthusiastically. Explicit export subsidies in the form of time-limited direct-to-consumer vouchers redeemable towards substantially all of a country's domestically produced goods and services should be deemed permissible, and the inevitable bureaucracy should be created to quibble over the terms of the institutionalized subsidy. Nations may choose to opt out of the program, but if they wish to offer subsidies, they must accept all other nations' subsidies. (Nations may accept subsidies without offering them, though.) Each subsidizing nation then sets an annual lump-sum amount, which is distributed in the form of equal-valued vouchers to adults in all participating nations worldwide. (Goverments that cannot brook direct-to-consumer payments would be excluded both from offering or accepting subsidies under the program.) Vouchers would be transferrable, but redeemable only by non-residents of the issuing country, for delivery outside of the issuing country. (Yes, for electronically deliverable services that might be hard to enforce. But that's what we have bureaucracies for.) In particular, subsidy vouchers could be bought and sold on organized exchanges, so that recipients who need food more than imports could sell them, for example to entrepreneurs hoping to purchase foreign capital goods at a discount.

I know this will grate on some of my "free-trade" luvin' readers, but please compare this proposal with the actual status quo rather than hypothetical optimization problem. Governments will subsidize, sometime corruptly, sometimes mistakenly, and sometimes because it is a good idea that they do so. This scheme does not directly address narrowly tailored subsidies (e.g. US farm subsidies), but it does provide an alternative and "less distorting" means by which nations can broadly support their tradable industries while picking winners and losers as little as possible. It will also provide an alternative to the current practice of synthetic subsidy via currency and financial market intervention, which has led us to the brink of depression and dramatically increased the likelihood of serious conflict, economic or otherwise, between major powers. Since governments will always subsidize, we should try to devise and institutionalize least-harmful-means by which governments can do what they will (and sometimes should) do. This proposal avoids government picking of winners and losers, encouraging governments to subsidize tradables very broadly defined but let markets fill in the details. It prevents governments from targeting and undermining tradables production in particular countries. It avoids the obscenity of the current decade, wherein the mechanics by which export subsides were arranged meant that the wealth transfer went primarily towards the consumption of the already wealthy (owners of real estate or financial assets). The aggregate demand required to mobilize China might have been generated by entrepreneurs building factories in Africa rather than homeowners buying lawn furniture in America. Also, the structure of the proposed subsidy means that poor countries can choose to accept it as a form of foreign aid whose direct-to-consumer requirement might limit corrupt misuse, and whose breadth renders the subsidy less harmful to domestic producers than, say, dumping underpriced grains onto the market in the name of charity.

I think this is a pretty good idea. Tell me why I am wrong.