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The textbook economic case for free trade agreements is that they constitute a Kaldor-Hicks improvement, which that in any given country the winners win more than the losers lose, when the benefits and losses are measured in dollars. (See this blog post by Steve Landsburg for a proof.) The reason that it matters that something is a Kaldor-Hicks improvement is that any Kaldor-Hicks improvement can be turned into a Pareto improvement, i.e. a policy that benefits some people and hurts no one, by having the winners pay the losers to compensate for the losses.

But the thing is, even though free-trade agreements are often argued for on the basis of this textbook case, once the agreement is passed the Kaldor-Hicks agreement is not actually turned into a Pareto improvement. This is illustrated well in this dialogue by Gene Callahan:

Joe: An unemployed steel worker.

Thaddeus: An economist holding a chair at Free Market U.

Joe: Boy, free trade sure hasn't worked out as promised. Just look at the devastation it has created in the Rust Belt.

Thaddeus: I can't imagine what you are talking about: why, I have a very sophisticated model in which it is clear there are always net gains from free trade.

Joe: What you mean by "model"?

Thaddeus: It is a mathematical abstraction, that leaves out large parts of the real world in order to reach a determinate result.

Joe: So if your model leaves out large parts of the real world, how do we know its results apply to the real world?

Thaddeus: I did mention that it is a very sophisticated model, didn't I?

Joe: OK, let's say I grant that the results of your model do apply to the real world. You said it shows that there are always "net gains" from free trade. That implies that some people gain while others lose. How do you decide that the gains of the gainers are greater the losses of the losers?

Thaddeus: We use a compensation principle: if those who gained from some free trade agreement could, in principle, compensate those who lost, so that both sides would now prefer the free trade outcome, then we can conclude that free trade creates net gains.

Joe: Can you give me a concrete example of how this works in practice, for instance, in terms of the steel industry?

Thaddeus: I am glad you asked, because of course I can! Free trade allowed the steel company you used to work for to shut the plant at which you worked and move that production to China. Certainly, this move devastated the lives of workers in your town, and essentially left the town for dead. But other people benefited, for instance the consumers of goods that contain steel, but especially people like the upper management of the steel company that endows my chair at Free Market University. Let me tell you, those executives are doing really, really well as a result of that plant moving! I've been to a party at the CEO's house, and the upgrades he's been able to commission are just fantastic. I've never seen an infinite pool so sweet. Plus, they have been able to double my speaking fees at their summer seminar series.

Joe: I see. So, per your compensation principle, you will be recommending that those executives give up a portion of their gains to help out the town they left in ruins?

Thaddeus: I'm sorry, did you miss the part about "the company that endows my chair"? Jeez, do we really have to wonder why low-IQ workers like you are suffering in the great, global economy?

So my question is, have there been any attempts to turn a free-trade agreement from a Kaldor-Hicks improvement to a Pareto improvement? That is, a policy that taxes the winners in order to compensate the losers.

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The US has a "Trade Adjustment Assistance" for (almost) this exact purpose.

Trade Adjustment Assistance (TAA) is a federal program of the United States government to act as a way to reduce the damaging impact of imports felt by certain sectors of the U.S. economy. The current structure features four components of Trade Adjustment Assistance: for workers, firms, farmers, and communities. ...it was proposed by President John F. Kennedy as part of the total package to open up free trade. President Kennedy said: "When considerations of national policy make it desirable to avoid higher tariffs, those injured by that competition should not be required to bear the full brunt of the impact. Rather, the burden of economic adjustment should be borne in part by the Federal Government."...As a 2012 Report by the Joint Economic Committee states: "TAA needs to remain an integral part of trade policy because it compensates those harmed by import competition without sacrificing the larger demonstrable benefits of trade

Trade Adjustment Assistance at Wikipedia

Canada had a program like this into the 1980's. The comparable EU program is called The European Globalisation Adjustment Fund.

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  • $\begingroup$ Do these programs attempt to fully compensate the losers for their losses, or just partially compensate them? $\endgroup$ – Keshav Srinivasan Mar 22 '17 at 20:57
  • $\begingroup$ They only crudely try to figure out individual level losses. $\endgroup$ – BKay Mar 22 '17 at 21:18
  • $\begingroup$ OK, but crude or not, their goal is to pay 100% of a person's losses, not some smaller percentage, right? $\endgroup$ – Keshav Srinivasan Mar 22 '17 at 22:37

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