October 30, 2010
The Free Trade Trap
Free trade sounds nice. Protectionism sounds ugly. Free trade sounds capitalist. Protectionism sounds Marxist. So it is worthy of note that free trade was actually viewed by Karl Marx as a strategic force, a tool with which to undermine capitalism as an economic model:
But, in general, the protective system of our day is conservative, while the free trade system is destructive. It breaks up old nationalities and pushes the antagonism of the proletariat and the bourgeoisie to the extreme point. In a word, the free trade system hastens the social revolution. It is in this revolutionary sense alone, gentlemen that I vote in favor of free trade [i].
Marx was not far from wrong. After nearly fifty years of progressive tariff reductions, America has suffered significant economic losses. This comes as a surprise to many Americans, for years inebriated with the free trade mantra.
This is because America does the "free" while the rest of the world does something else. China, for example, manipulates its currency and engages in persistent dumping, driving down Chinese prices and displacing domestic American industries.
And China is not the only nation taking advantage of friendly American trade policies. The European Union and Canada are abusing arbitration procedures under the WTO to attack legitimate American practices while refusing to reciprocate. The EU, for example, obtained WTO injunctions declaring U.S. tax breaks for exporters "illegal" but then refused to remove its own VAT rebate for European exporters [ii]. The EU claimed that the U.S. tax breaks were the same as a "subsidy." Strictly speaking, a subsidy is an amount given by government, while tax breaks are an amount not taken by government. But more importantly, EU agricultural subsidies are the largest in the world. EU subsidies account for 88 percent of the world total, according to the U.N. Conference on Trade and Development (UNCTAD) [iii].
Besides the lack of reciprocity, the aforementioned WTO ruling violates traditional principles of international law, since whatever a nation determines within its borders is legal.
The results of such one-sided free trade have been catastrophic for America. Consider that in the last fifty years, U.S. tariffs have gone from 40 percent of the price of goods to 5 percent [iv]. Over the same period, manufacturing as a share of employment has fallen from 30 percent to 11 percent and is still falling.
For the first seventy years of the 20th century -- all protectionist years -- America ran trade surpluses. Now, in 24 of 114 key industries, imports have seized half of the U.S. market. In eight premier American industries, including automobiles, imports have seized nearly 70 percent of the U.S. market [v].
Before NAFTA, American tariff reductions were pursued on a multilateral basis, and tariffs could always be reimposed selectively to safeguard vital industries. NAFTA, and later the WTO, shifted this dynamic considerably, resulting in net job losses and severe wage depression.
Free trade advocates habitually cite David Ricardo's theory of "comparative advantage" to justify unfettered globalization of industry even at the expense of jobs and wealth. They contend that the doctrine of "comparative advantage" requires that industrialized nations morph into service economies, while underdeveloped nations, benefiting from historically low trade barriers, focus on producing cheap, labor-intensive goods. The U.S. is a perfect example of this Western trend. According to the Office of the U.S. Trade Representative, services account for over 80 percent of U.S. GDP and employment [vi]. In essence, the argument is for wealth redistribution in alignment with cost, with free trade serving as the great leveler. At its core, "comparative advantage" has been used to justify a form of global Marxism.
This is a perversion of David Ricardo's concept. Ricardo lived in a time of resource-centered production. Nations traded finished goods assembled from raw materials extracted from a given domestic economy. Today, most trade consists of "turnaround" products that are assembled all over the world and reimported for consumption [vii].
Ricardo would say that Mediterranean climates are more conducive to wine production and woolen goods are easier to produce in England, where adequate pasturing for sheep exists. Therefore, it would be more efficient for an Englishman to convert his vineyards to sheep pastures and his winery to a woolens mill. The existence of the necessary resources was the determining factor, not cost, as in today's global market.
And "comparative advantage" was deemed favorable by Ricardo only if three conditions were met: zero international capital mobility, full employment, and balanced trade. But under the current global economic model, capital is indeed very mobile, employment is often adversely affected by this mobility, and the balance of trade is completely disregarded.
The late Milton Friedman was a committed free trade proponent. In a stunning dismissal of traditional economic theory, Friedman once remarked, "Who is hurt and who benefits ... U.S. consumers benefit. They get cheap TV sets or automobiles ... Should we complain about such a program of reverse foreign aid?"
That may sound good for the short-term, but, as classic economist Friedrich List wrote,
The forces of production are the tree on which wealth grows...The tree which bears the fruit is of itself of greater value than the fruit itself...The prosperity of a nation is not...greater in the proportion in which it has amassed more wealth (i.e. values of exchange), but in the proportion with which it has more developed its powers of production.
Manufacturing matters. Service jobs, the primary source of U.S. employment, depend on capital inputs from manufacturing even if said manufacturing is foreign. This presents problems should foreign manufacturing undergo shocks or disturbances that disrupt supply lines and, by extension, the sole source of employment for most Americans. Dependence on foreign manufacturing is inherently dangerous, since it is out of U.S. control.
The loss of manufacturing is not a trivial matter, and it has national security implications. It must be the ultimate oxymoron that Communist China is now the "arsenal of democracy." China is a strategic enemy and has threatened open nuclear war on America's homeland, and yet CFIUS has cleared the sale of factories to China responsible for producing the rare-earth magnets used in American laser-guided munitions. What happens if America ever needs to fight China?
Service economies can't issue ultimatums; only industrial economies can do that.
It is on this basis that free trade arguments fall apart. In a world with no nations, where national governments are not accountable for the economic and political security of their people, doctrines like "comparative advantage" would have validity. But as it stands now, there is real utility attached to the maintenance of a buoyant manufacturing sector, promise of lower prices notwithstanding.
In point of fact, the "global economy" is an artificial construct created through the voluntary lowering of tariff and non-tariff barriers -- barriers that can again be erected. Furthermore, when other countries continue to employ tariffs and other traditional "isolationist" tools, America must use similar devices in order to "compete" effectively. Refusing to protect the American economy when other nations are using manipulative "protectionist" devices is not competition, but economic suicide.
Free trade cannot work when some play by the rules and others do not. While competition and openness are desirable in ideal circumstances, reasonable protectionism has proven effective and is indeed necessary to preserve American economic strength.
[i] Karl Marx, "On the Question of Free Trade," Democratic Association of Brussels, Brussels, 9 Jan. 1848.
[ii] World Trade Organization, Report of the Appellate Body, WT/DS108/AB/R, United States-Tax Treatment for "Foreign Sales Corporations," 24 February 2000.
[iii] Ralf Peters, "Roadblock to Reform: The Persistence of Agricultural Export Subsidies," UNCTAD, (Geneva: UNCTAD, 2006), 4.
[iv] Lester Brown et. al., Vital Signs 1993: The Trends that are Shaping our Future," (Washington DC: Worldwatch Institute, 1993), 74-75.
[vi]Douglas B. Cleveland, "The Role of Services in the Modern US Economy," Jan. 1999, International Trade Administration, <http://www.ita.doc.gov/td/sif/PDF/ROLSERV199.pdf>, (30 June 2009).