June 15, 2015

Rethinking Free Trade

Let me start with where I started on this. I've always be a supporter of free trade. Here's why. The concept of free trade is one that benefits both consumers and producers, across borders.  The idea is rooted in the fundamental economic concept of specialization. If America makes tractors better (more efficiently) than South Korea and the latter nation makes smart phones better than America, there is a benefit to America making tractors, South Korea making mobile phones and the two nations trading to obtain the commodities they need from each other.

Why does that benefit consumers? Americans have access to better phones or the same quality of phones at cheaper prices by having access to those from South Korea.  If a new manufacturer wants to sell phones they will have to compete with the best available or they simply won't succeed.  Consumers' benefits are extended because new entrants, and existing entities are forced to improve upon the status quo or they will not succeed. The same is true in South Korea for tractors.

Why do producers benefit? It combats complacency. Companies fall into the success trap. Polaroid nearly died as  a business because they did not change to accommodate the digital age. Polaroid isn't actually the perfect example because it is a re-success story now.  Being forced to compete, invigorates companies and keeps them moving forward - innovating and improving productivity. The alternative is to wither and die.

Specialization is good for all and Free Trade supports that by delivering the greatest good to the greatest number of people, globally thanks to the concept of comparative advantage. Based on that, anyone who is against Free Trade is acting against their own best interest as well as the greater good.

But in the real world, Free Trade has garnered mixed results and rethinking free trade is not only a good idea, it's a necessity.  The reason is that Free Trade, in practice is not so simple. It's not entirely free.

Firstly free trade is distorted by government in a number of ways. Governments often protect their own markets, tacitly or overtly.  In 2003 Japan banned U.S. beef imports as a result of a single case of Mad Cow Disease out of millions of heads of U.S. cattle.  The ban lasted until December 2005. It was followed by another ban in January 2006 on a spurious, unrelated issue. Taking advantage of safety concerns, Japan was able to protect its domestic beef producers unfairly, for a very long time. Japan had been the largest export market for U.S. beef. With the duplicitous trade barrier, Japan managed to hurt both American producers and Japanese consumers at the same time.  No doubt the domestic farm lobby in Japan was pleased by the reduction in competition but in the long run, they would have been hurt as well.  American consumers also were prevented from reaping the benefits of comparative advantage as some Japanese labor was being kept in less efficient occupations than where they had comparative advantage. Barriers, duties/tariffs, product bans, all impede free trade. By not retaliating in kind the U.S. could avoid a trade war, but free trade then is just mostly-Free-Trade.  The Japanese example is not an isolated example, it's pretty common in fact.

Free trade of course should prohibit subsidies but the current current trade environment is rife with not only subsidies disguised as something else, but also trade with nations whose production is nominally or perhaps subtly operationalized by government entities, child or slave labor (prison-based production for example). Even the most ardent free trade proponent cannot condone either case, which ensures labor costs are unnaturally low and produces the opposite of free trade's intent - to produce the greatest good for the greatest number of people.  Those laboring under those conditions are not enjoying their greatest good.  They are often in fact, suffering.

Then of course there are national security concerns.  Does America want sensitive materials produced offshore? Oil, aircraft engine parts for jet fighters for example really make sense to produce at home wherever possible.  In the event of a shooting war, if those things can be cut off, is national security compromised? Yes. In addition when you have nations hacking the U.S. for both military and industrial espionage, they are subverting not only national security but they are compromising comparative advantage.  Unless you want to outsource your espionage because China seems to have a comparative advantage in that, spying does not make things fairer.

It often seems like Free Trade agreements have become an excuse for a race to the bottom. Job offshoring is a byproduct of free trade.  Ostensibly, the cheapest producer wins. But as they offshore jobs, the domestic market, cannot immediately replace those jobs if there is no obvious comparative advantage opportunities or those options already have a relative market equilibrium and cannot absorb more labor. This is complicated by tacit protectionism abroad. Displaced workers become a drain on the economy and hamper domestic comparative advantage as social support structures feel additional strain, increasing inefficiency as demands are placed on on producers and other consumers to provide additional support for social safety nets.  That further drives the need to offshore production.

Over time, as wealth rises, domestic consumption in India and China (for example), should pressure wage inflation and drive down their comparative advantage. Production would then likely move on to other places like Bangladesh, Vietnam, or Nigeria perhaps.  Over a longer period, perhaps centuries, a level labor playing field might emerge.  Labor costs the same across all nations for similar roles is a good thing.  But that won't happen in our lifetime unless science conquers the aging process.

Henry Ford realized that the producers are also the consumers and paid his workers enough that they could afford his products.  Perhaps he overpaid them.  I'm not suggesting we need to go that far, only that if there are no domestic consumers, there is no domestic market, and that should factor in the calculus of a corporation.  Additionally, in the headlong rush to China corporations who adhere to the solitary notion of a bottom line, myopically ignore the fact that they have the freedom to operate as they do  because of the national security of that domestic market.  If they seek the same fair deal from China's current regime in 20 years because that's where they are and all the business is, they are going to be disappointed. In fact, they might find their businesses being nationalized. 

It might sound like I have abandon the idea of free trade and lost faith in America's ability to compete.  Neither is true.  What I have abandon the notion of free trade at all costs.  America operates in the real world and there is no level playing field.  America is competing with an arm tied behind it's back while countries like China have brought a baseball bat to the table.  Ronald Reagan said with regard to the Soviets trust but verify.  Free Trade Agreements are no different.The view America must take on free trade is that it only must be pursued when it is in America's best interest. That means for all Americans - producers, consumers and laborers alike.  It means that deals must be looked at not only in terms of foreign markets but what it means for domestic markets.  It means looking at both short term and long term impacts.  It means that national security must be a consideration.  Not all free trade deals are equal, and leadership must not be beholden to a particular lobby.

That common sense seems to be lacking in general and to the recent dismay of many, the Republican Party. My advice to them is simple: support free trade, but not with blinders to reality.

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