The Thinking 

Free Trade: The Luxury We Can No Longer Afford

March 20, 2011



One commenter in the previous discussion mentioned Toyota, I would like to hold that company up to the claim made by another reader that protectionism always leads to shoddy union practices and inferior products. Interested readers might like to review the history of that superlative manufacturer when evaluating theoretical objections to protectionism.

I believe they will find that this particular bit of received wisdom (like most of the other bits), does not stand up to historical scrutiny. “Free traders” are beginning to sound embarrassingly like old Marxists in their dogged insistence that their theories do to work, it’s just that the real world with real humans keeps gumming up the works in their beautiful system. (There was a great comment in my local paper yesterday cynically pointing out how – I paraphrase – “we’re always just one more “free” trade treaty away from turning our economy around with an export-driven boom.” Romantic libertarians probably don’t appreciate that sort of black humor.)

The dogma that unilateral free trade is of benefit to the nation that practices is a bit of self-serving cant first embraced and promulgated by top-dog manufacturers who were at the time in a position to benefit from it. Because it does, as a matter of fact, work nicely under those very limited conditions. It can also be practiced by a nation that has built up such an overwhelming advantage that it can absorb, for a time, the job- and economy-killing effects of persistent trade deficits. Unfortunately the successful tend to become stupid and start believing their own cant. The results may be viewed in the trade data of the last few decades.





                       — Comments —


George S. writes:

R. S. writes of the “economy-killing effects of persistent trade deficits.”

The “trade deficits” idea is just smoke and mirrors. I personally have a trade deficit with Walmart and Target. I buy their products and yet they buy nothing from me, OH NO, better outlaw some free trade! I’ve also had products shipped to me international from England, Germany, and Japan. Which means I personally have a trade deficit with those countries, OH NO, better stop them from taking advantage of me!

Protectionism is also one of the major causes of war. England and France were at war with each other for centuries until they started trading with each other on a large scale. With that trade war became too costly. This was true of many European nations across time. Japan is in no danger of another nuclear attack by the United States so long as they continue to sell us Nintendo Wii. The American Revolution came about primarily due to British tariffs and taxes. Before the outbreak of the first and second World Wars, free trade also broke down.

You don’t bomb where you get your bread from and you don’t bomb where you get your fine consumer electronics from. As Frederic Bastiat has said: “When goods cannot cross borders, armies will.”

If you want to make the world an objectively worse place to live in then follow the path of a closed economy and you’ll get there, just like every other nation that tried it has.

Laura writes:

I don’t think anyone is advocating a closed economy! To argue for more protectionism is not to argue for an end to international trade. Rather, it is to argue for wiser and shrewder trade.

Clark Coleman writes:

The free-trade commentators on your entries showed no signs of reading Ian Fletcher’s book, Free Trade Doesn’t Work: What Should Replace It and Why, or even bothering to watch the half hour video interview that you linked. Instead, they smugly assured us all that the argument was settled long ago. They don’t have the foggiest clue what they are talking about.

When Adam Smith developed the theory of absolute advantage in trade, and David Ricardo shortly thereafter generalized it to the theory of comparative advantage, the world economy was largely agricultural. Each country had a given amount of productive land. The question was, What should the land be used to grow? Should each nation strive to be “self-sufficient” by growing a little of everything, or should each nation grow what it grows best, given its soil and climate? By the time Ricardo and his followers had refined the theory of comparative advantage, it could be said in fairness that it had been mathematically proven that countries should grow the crops that they can grow with relative efficiency, trade with other nations to acquire the other crops, and not seek total self-sufficiency.

This idea has been carried over into the modern economy, as demonstrated in a column by Walter Williams that I read a couple of years ago, in which he said something like the following: “Should the United States try to produce semiconductors AND grow its own tomatoes, or should it produce semiconductors and let Mexico grow tomatoes (a labor-intensive crop) and then trade for the cheaper Mexican tomatoes?” My immediate rebuttal to Williams was this: How about if Mexico grows tomatoes, AND we ship our semiconductor plants to Mexico, and produce both semiconductors and tomatoes in Mexico?

This is where the analogy to the era of Adam Smith and David Ricardo breaks down. An agricultural nation cannot ship its soil to another nation, under ownership of a corporation, and grow its crops overseas and then buy them as imports. For one thing, that would leave almost the entire population of the nation unemployed, and how could they then afford to buy imported food? Smith and Ricardo took it for granted that the home soil would be used to grow something; the question was, which crops?

You might look at my semiconductors and tomatoes example and ask, What will Americans do for employment and income in this scenario, if the logic is carried beyond semiconductors and tomatoes to every product, every crop, and every factory that can possibly be moved offshore? Good question, but that is not the problem of the semiconductor CEO. He has the next couple of years’ profits to worry about. He is in charge of a single company, not a national economic policy. If he does not move his plant, and a rival does, he might be undercut in labor costs and go out of business. The tomato company CEO has a similar, isolated responsibility. Walter Williams’ scenario almost implies that the two CEOs get together and decide to keep the semiconductor jobs in the USA and move the tomato jobs to Mexico. It does not work that way.

In the language of Smith and Ricardo, many nations in the world have an absolute advantage, not a comparative advantage, over the USA in all products and crops that has sufficient labor content to overcome the inefficiencies of moving the jobs out of the USA and transporting the products back to the USA. With communications and transportation costs and times far below what Smith and Ricardo ever dreamed of, that includes most of the products made in this world today.

Note that Mexico has no ability to create a semiconductor industry. They don’t have the knowledge or the huge amount of capital required. Yet, we can relocate all the capital equipment as well as our knowledge, as a free gift to Mexico in return for having cheap labor available to work in the plant. Smith and Ricardo never dreamed of such a world.

There are three kind of jobs in America today:

1) Jobs that can be moved directly offshore, because there is no reason that they have to stay here. Many are already gone, the others have a big fat target painted on their backs.

2) Jobs that have to stay here (teachers, hospital workers, restaurant workers, etc.) because the jobs have to stay in proximity to clients (students, hospital patients, restaurant customers, etc.) The corporate solution here is to import cheap labor, legal or illegal, to take jobs and drive wages down, because the jobs cannot become part of category #1.

3) Because some expense is involved in offshoring category 1 jobs, and corporations cannot import as many immigrants as they want for category 2 jobs, and the CEOs and others making decisions want to remain residents of the USA, there are jobs still in this country. This category 3 would be much smaller if corporate CEOs could have their way with visa quotas of various types (for both skilled and unskilled workers).

Adam Smith and David Ricardo were not referring to any of the above when they talked about “trade,” as “trade” is not the importing of cheap labor, or the exporting of capital equipment to countries that can barely learn how to use the equipment. But free off-shoring is referred to today, euphemistically, as free trade.

Wes writes:

In response to Clark Coleman, is it quite true that centuries ago agriculture was the Queen of economics, and manufacturing relatively insignificant. But then it took fewer and fewer agricultural laborers to produce increasingly greater output. Now, with the dwindling of manufacturing laborers, how can we free traders be so sanguine about everything? Because manufacturing output (ours, and the world’s) has been increasing. Because that often denigrated “service economy” has been slowly taking over manufacturing as the prime mover. 

To me, the argument against outsourcing labor doesn’t sound very different from the argument against automation in manufacturing. Machines will eventually take over even those presently penny-paid, peasant-filled manufacturing jobs, in time. “But what will all our unemployed laborers do?” Well, what did they do with the automation of agriculture? Economies evolve, and so does just what people do every day to make a living. What we are in fact doing now is moving towards a more service-oriented economy. We spend over two-thirds of our personal consumption on services presently, as an example. 

The health and strength of our economy is not just about making more things, or ensuring that any Joe American can walk onto the factory floor with his GED and rake $20 an hour. Is the physical activity of working on an assembly line really what we’re trying to save? No. The purpose of production is consumption. The cheaper we can produce things, the cheaper we ourselves can buy things, and the more the producer profits. Yes, profits, though that word has a strangely sinister connotation in many of the comments I’ve read. 

But that profit (i.e. real wealth, created from nothing) is not hoarded under some greedy zillionaire’s bed. It becomes productive capital, used in an infinitude of avenues that result in further innovation, and the creation of new industries we can’t even think of at present. That’s what has happened in the past, that’s what will happen in the future, and that’s what we can more fully take part in if we so choose. So why wouldn’t we? It’s an emotional subject because particular job losses are so immediate and personal, but we should be looking at the long-term effects as well, and the diffused greater good for everyone.

R.S. writes:

Laura writes: “I don’t think anyone is advocating a closed economy.”

Indeed. I’ve never met such a creature, though he looms very large in the perfervid imaginations of some trade theoreticians.

George S.  writes: “The American Revolution came about primarily due to British tariffs and taxes.”

And after the revolution the U.S. grew into an economic powerhouse under, for most of its history, policies of targeted protectionism. As did every other modern nation that has hauled itself up from poverty to wealth. You can argue by assertion that existing First World nations got that way by scrupulous adherence to the doctrine of “free trade” until you are blue in the face, but that conviction belongs firmly in the category of “things that ain’t so”.

George says, “Before the outbreak of the first and second World Wars, free trade also broke down.”

Lots of stuff happened before the outbreak of the great twentieth century wars. The breakdown of trade and the outbreak of war were not cause and consequence, but two consequences of the same deteriorating conditions.

“You don’t bomb where you get your bread from and you don’t bomb where you get your fine consumer electronics from. As Frederic Bastiat has said: ‘When goods cannot cross borders, armies will.'”

Of course you don’t – because once you’ve ceded all the fine consumer electronics manufacturing you begin to bleed the rest of your industrial base, losing generations’ worth of engineering know-how and mojo in the process, and will inevitably lose your own military technological capacity as any large-enough rival to whom you’re willy-nilly ceding your productive base improves and increases his own. You won’t make war, not because the conditions for war will have been obliterated by tight economic integration, but because you can’t. Somtimes wars are lost without armies ever having to cross borders. (With all due respect, I suggest that you expand your reading of real-world economic history beyond Bastiat. Particularly if you truly believe in all sincerity that large chronic trade deficits are irrelevant.)

Clark Coleman: Nice summary. “Comparative advantage” always struck me as a very clear and easily grasped concept, yet it has to be the most frustratingly misunderstand and misused term in all of modern political and economic debate. You wouldn’t think that the question “How are wool and wine not analogous to semi-conductors?” would be that much of a puzzler, but here we are.

Regarding your “three kinds of jobs:” sad but true. As Craig Barrett was quoted as saying, “Intel can move wherever it must to thrive, but I sometimes wonder how my grandchildren will earn a living.” Not, I suspect, that Mr. Barrett or his like has much beyond an “après nous le déluge” orientation to the whole mess, but the pessimism is a refreshing improvement on the “New Economy” bilge that still hasn’t quite been consigned to the oblivion it deserves.

Thomas F. Bertonneau writes:

George S. writes, “You don’t bomb where you get your bread from and you don’t bomb where you get your fine consumer electronics from.”  The notion that trading partners never go to war is nonsense.  Sometimes nations keep trading while in active conflict, as the North and the South did, by various subterfuges, during the Civil War, and as the USA and the USSR did throughout the Cold War.  But trade relations simply do not preclude war.  Germany and Poland were trading partners until 1 September 1939; Germany and Russia were trading partners until 21 June 1941.  Italy and Great Britain were trading partners until 10 June 1940, as also were Italy and France.  Germany and France were tightly knit trading partners on 18 July 1870 and the next day they were at war.  The USA is currently bombing Libya, with which it has trade relations. 

On imported labor and automation:  The effect of automation has always been to make goods cheaper, the effect that “free traders” seem to put first among values.  Sending the campesinos home and readmitting them in fewer numbers only under the strictest bracero rules might well create the financial incentive to automate the Imperial-Valley harvest at last.  Lettuce would be even cheaper than it is when picked by the campesinos.  How about it, free traders?  Let’s try it for ten years and see what happens.  The two views would be tested and we would have extraordinarily useful knowledge.

R.S. writes:

Wes forgot the “buggy whip” reference.  No enumeration of neoliberal economic talking points is complete without a “buggy whip” reference. 

Wes  writes, “Because that often denigrated “service economy” has been slowly taking over manufacturing as the prime mover.”

Service Economy was last spotted taking a left turn at the Pacific and going to keep company with Manufacturing Economy in places like India and China.  He’s going to send some people he met in those places to take up any on-site jobs left in the U.S.

The old joke about “Brazil being the country of the future” can be refashioned and fit-to-purpose here.  Which it should be, because Brazil isn’t an economic joke, whereas the “service economy” will always be “the economy of the future”.

I’ve had a bet with myself since 1995 or so, about when we’d see the last non-ironical use of “service economy” or “new economy.”  I keep losing. I first predicted 2005 for the last sighting, but the examples kept flooding in.  Then I pegged it at 2010, and was partly vindicated, as even some of the daffiest Panglossians began stubbing their toes on the facts-on-the-ground.  Still, I should’ve known better. There are, after all, honest-to-God Maoists yet running around, so there’s no reason why I won’t be sitting in the old folks’ home listening to some fellow geezer expatiate on how “service jobs would have turned the economy around if it weren’t for the red tape and the regulations…”
Wes, no serious thinker believes that a large nation can maintain itself, defend itself, and prosper as a “service economy.”  Shills, hacks, CNBC screechers, Timothy Geithner, professors at George Mason, and Economist leader-writers, yes, but not serious people.

Wes writes, “It becomes productive capital, used in an infinitude of avenues that result in further innovation, and the creation of new industries we can’t even think of at present.”

Yes, it will.  And that productive capital can in future be invested in places that are not the United States, for exactly the same reasons that productive capital has been invested in existing industries, in places that are not the United States, and exactly the same reasons that productive capital is being invested in new industries, in places that are not the United States.

I direct you to a point I made in a previous post, about “innovation and the shop floor.”  It’s important, and the problems therein are not addressed in your simplistic economic model, nor can they be addressed by ritualistic invocations of “Luddite” or “buggy whip,” or the glorious future of the Diffuse Greater Good to be wrought by the Invisible Hand after we grind under a few generations that happened to have the bad luck to get the “destruction” end of the creative-destruction magic wand.

Wes states, “Yes, profits, though that word has a strangely sinister connotation in many of the comments I’ve read.”

No, you’re reading that into the comments yourself, because you’re assuming that anybody who questions neoliberal economic dogma is some wet business-hating socialist who has yet to be exposed to Smith’n’Ricardo 101 or liberated from ignorance by Bastiat or the Austrians.  I’d recommend ditching that misapprehension and having a fresh go at the comments.

Mr. Coleman writes:

It seems that quite a bit of Wes’ reply is directed more at the arguments that he often hears from protectionists, rather than at what I specifically said. For example, I do not say “manufacturing = good; service = bad” when it comes to jobs. Lots of service jobs are high paying, such as lawyers. I work with computer software; that is a service job, so I understand that the old canard “service job = burger flipper” is nonsense.

The example of automating agricultural jobs in the 1800s, and the displaced workers finding new jobs, is instructive. I often use it to show that economic analysis must be dynamic, not static. But let’s think about it in more detail. Due to agricultural automation, we went from spending more than half the typical family income/labor on food to spending a small fraction of our budget on food (before everyone started eating out all the time!). So, the savings were so great that families could now buy washing machines, dryers, refrigerators, vacuum cleaners, automobiles, etc. This created jobs in factories to make all these items, absorbing the displaced farm workers into factory jobs that were ultimately better jobs than the ones they lost. (Of course, a minority of the displaced farm workers even found factory jobs making agricultural machinery.)

Here is a thought experiment: What if we had displaced the same number of farm workers, but the payoff was only a 5 percent reduction in food prices? Would the net outcome of this economic transformation have been positive? How about a 3 percent reduction in food prices? How about 1 percent?

Follow-up question: When a company calculates that it can make a dollar’s worth of product for 60 cents by moving the production overseas, and that the added transportation and long distance costs will bring the total costs back up to 93 cents, is this a net win for the economy? I would guess that the answer would depend on exactly how many jobs are lost, exactly how much discretionary income will be created in the average family as a result of their paying less for whatever this product is, how many jobs will likely be created by that extra discretionary income, what effect on tax revenues from the company and workers will occur, etc. So, it matters whether the final cost of making that product overseas is 97 cents on the dollar, or 92 cents, or 80 cents, or 60 cents. But, to a CEO, if current profit margins are just 6 percent on this product, and a rival is moving overseas and will soon cut prices by 3%, he is facing the loss of half of his profit margin if he does not follow suit. So, he will move those jobs overseas whether the answer is 97 cents or 60 cents on the dollar.

In other words, the mechanization of agriculture was a once-in-history economic transformation that makes a poor analogy for many job losses today. The free trade ideologues do not distinguish between the 97 cents on the dollar case and the 60 cents on the dollar case. They are just repeating dogma, not analyzing particular cases.

As an aside, I do not favor using tariffs in general to protect our jobs. I consider them a last resort and favor some significant changes to our tax code and our regulatory system first, at which point I think very little would be needed in the way of tariffs. But I still take issue with the rosy scenarios that come from ideology.

Wes writes:

Well, I can’t say I’m a real serious guy, more ‘mellow.’ I just couldn’t think of a plainer term than “service economy” for what I saw here and here. (Breakdowns of those categories available at the BEA.) We now spend twice as much on services as on goods, at the same time as our domestic goods production increases and requires fewer workers. I mean, there is a point where we make enough stuff, isn’t there? Eventually, maybe… maybe even right now. If not, is there at least a point where we ourselves consume enough stuff? I should hope so. But the ‘services’ can employ any number of people, conceptually—we just have a lack of imagination at present. (For any curious what that could look like, I will relink this essay I find insightful).
As far as productive capital from outsourced enterprises vanishing into the depths of other countries’ economies, never to return… well, I guess we’re hosed here in America, then. Hopefully those weasels will at least let us buy some of their cheap goods after all our help. Have we become a capital sieve where nothing comes back around? Or a capital electromagnet with the polarity reversed, so we actively repulse it? Best to plug those holes and only trade reasonably with our buds? Or, figure out why capital would flee in the first place—which I believe Mr. Coleman mostly nailed as our tax disincentives and libraries of regulations. I would add our minimum wage laws as well. (And just in full disclosure of my ideology, in case any of my comments should merit further dissecting: I myself worship at the altar of Georgism.)







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