How Much Free Trade is Free?

Getting Fat on Free TradeLet me preface this by explaining, I believe in lowering taxes everywhere we can. It just makes good sense. Without exception when taxes are lowered business increases and government receipts increase. What about import tariffs? Tariffs are taxes and lowering or eliminating them stimulates trade, more economic activity, and thus more taxes through greater income and sales. Prior to the 16th Amendment, legalizing the income tax, the bulk of federal receipts came in the form of tariffs. As the proliferation of free trade agreements has grown revenue from tariffs has been on a decline while income taxes have grown in importance as a source of replacement income for the government.

When we discuss tariffs, it is important to understand who benefits and who does not. Naturally, the federal government benefits as tariffs increase the revenues, domestic producers benefit as they are afforded a degree of protection against cheap foreign competition, and domestic workers benefit by virtue of the protection afforded their companies. The losers in the tariff game are consumers who must pay higher prices for imports and domestic products that are unable to reduce their costs due to the tariffs.

I wish trade policy were only this simple. Unfortunately, as Free Trade proponents will correctly point out, no tariff lives in a vacuum. When the U.S. imposes a tariff on say Japanese automakers to protect U.S. automakers, the Japanese government will in turn impose its own tariff on a U.S. import, like beef. Soon a trade war begins and the world economy is negatively impacted. As this chart from Pitzer College illustrates tariffs artificially increase price and potentially decrease supply (should domestic suppliers not adequately fill the void.)

Earlier I mentioned that domestic businesses were aided by import tariffs but interestingly domestic businesses also benefit by removing import tariffs. When import tariffs are removed, U.S. companies are free to outsource. Businesses can move various parts of their processes to locations abroad that offer the lowest cost. Thus, the overall world economy is made more efficient by the lowering of trade barriers. The economic theory says that each country will produce those products it can produce most efficiently. This is a great benefit for multinational companies that can take advantage of it. In turn, it is a great advantage to consumers, as nearly all studies have concluded import tariffs significantly raise consumer costs through higher prices. A no-brainer, really.

Nevertheless, and yes this is where I get into trouble, is this good for the U.S. consumers in the long-term? I agree that in the shorter term, (meaning 0-15 years), free trade is a “nothing-but-net” slam-dunk win. I have my doubt about its long-term benefits. Liberals argue stockholders and business executives win while workers see their jobs whisked away to far off pockets of impoverished slave labor factories. They will lament the poor living conditions of those workers and point out how Americans are profiting from their misery. They may even complain that U.S. factory workers once making $20 an hour are reduced to working minimum wage jobs or worse standing in unemployment lines. (But you probably won’t find them lining up for a more expensive American made car.)  I decided to research the wage issue and I found that since 1980 there has been very little change in the inflation-adjusted wages of Americans. However, this chart shows an average wage, which includes executives and janitors. So while executives expand their income through higher profit (and I don’t begrudge them earning more), nonfarm, nonsupervisory wages are decreasing. However, we all know we’re in the midst of a global recession.

So far, my argument has been pro-free trade, but I have serious concerns over free trade as a long-term policy. The obvious benefits of adopting a free trade regime is the lower cost of goods and the freeing of resources to produce items in which our country has a comparative advantage. However, my concern is not about the advantage but rather the costs. The one cost nearly everyone recognizes is the loss of American jobs. I would like to add another, the loss of knowledge and innovation.

As we ship technical and manufacturing jobs overseas in search of ever-cheaper labor we are losing the ability not only to manufacture goods efficiently here but we are losing the ability to innovate new product ideas. U.S. companies not only export low-tech factory jobs but also have begun exporting knowledge-based jobs, such as recruiting R&D engineers in Asia. These engineers cost less and have economical access to production plants.

Excessive dependence on too few exports is another risk presented by free trade agreements. If a nation reduces the diversification of its industries to only those in which it has a comparative advantage, there is risk to the economy if global demand should drop for those products. This is closely related to another risk, the risk that an industry might be permitted to die and this could come at a cost to national security; such as losing the ability to produce aircraft, automobiles (thus tanks), or shipbuilding. Yet another risk is losing an historic industry, such as the auto industry. What happens if we find ourselves the victim of an economic embargo? Probably not much today but in 20 years it might be a different story.

Lowering tariffs naturally leads to outsourcing, as we have seen. This results in workforce reductions. Companies are freed to provide lower priced products but the discretionary spending of consumers is lower slightly, (through higher unemployment and lower income), which produces an increased demand for lower prices. This precipitates more outsourcing, automation, and/or other job reductions to facilitate still lower prices. This again lowers aggregate income slightly, thus discretionary spending and so the cycle repeats. Corporations benefit, stockholders benefit, host nations benefit (for a while), but we ultimately pay a long-term economic cost in the form of a reduced standard of living.

It is a very slow turning wheel because people find new sources of employment as technology changes and these new jobs come and go. Simple logic should tell us that you couldn’t put a hole in a bucket and expect the rain to keep it full. Alright, not the best analogy, my point is resources are flowing away from our country faster than they are flowing in. How long can this go on? I would argue until the standard of living is obviously impacted, then the people revolt.

Finally, many trade agreements are lopsided benefiting one partner more than the other. For example, The 2007 KORUS free trade agreement with Korea lowered nearly all restrictions on South Korean imports to the U.S. yet permitted South Korea to maintain nearly all of its barriers against U.S. auto imports. I keep hearing people say, “Let it die” – these people are not strategic thinkers. We need the auto industry, it is the backbone of what makes our nation strong, and it is a historically American product. Granted we need to address problems associated with bad management and poor labor arrangements. Part of the labor problem is the American standard of living. No American factory worker would tolerate living in a small hut and unable to purchase a car him or herself, yet in some countries, this is normal. I say forcing the auto industry to redesign its business model, coupled with a loan, and a modest import tariff on imported automobiles would be a reasonable bailout. Letting it die would be reckless. Do you really want to displace so many additional American workers?  My opinion is that the use of tariffs and subsidies is justified here.  Using tariffs in this sort of bailout makes far more sense than throwing money at the big 3.

We have being giving the house away in free trade agreements that do not benefit the long-term economic or strategic interest of America as a whole. We have getting fat off cheap stuff from China while throwing our own jobs under the container ship without realizing there is a price to pay. What will the American economy look like in 40 years? Can a purely service-oriented economy maintain our current standard of living?

Just because we can does not mean we should. Are protectionist tariffs the answer? Should we use tariffs to protect American industries like the auto industry?  Should we demand workers in other countries make competitive wages? (I made myself chuckle) Do we tax the crap out of business that ship jobs overseas? Do we force American companies to just finish the job and move completely offshore? How far do we go in job creation and what types of jobs do we want?

US flag Made in ChinaI’ll leave you with this interesting thought; I am a history buff and a few years ago, I was reading a book containing a letter from a British soldier stationed in the American colonies just prior to the Revolution. A paraphrase from memory goes something like this, “These colonists would procure their flags from the enemy if they could save a farthing.”* Last year, on the 4th of July, my daughter commented that our Walmart-purchased flags were made in China.  Guess it’s true.

* Farthing: Smallest British Imperial currency measure. 4 farthings made 1 penny.

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  1. Being a tried and true supply sider, I am big on free trade too. I’m not that concerned about long term issues related to free trade since the market is so flexible. The main thing we should as a society embrace is the idea that education is the most important thing. If you decide not to have any marketable skills, then you will always be stuck in minimum wage jobs. (The minimum wage is a whole ‘nother issue. Don’t get me started!) Of course you can always get OUT of those jobs if you decide to go back to school but of course it’s harder when you’re an adult. The opportunities are there for every one and it’s each individuals responsibility to gauge the market and prepare themselves for what is coming. But I think individual responsibility is a dying concept.

    Bottom line: free trade creates more opportunities for everyone, not just the business owners. If the production jobs go away, the increased trade should help expand the retail market. Anyway, me like free trade!

  2. I recently studied Free Trade theory and while I like the concept there is a long-term price to pay and a limited amount of trade barriers mostly in the form of tariffs I believe are necessary to protect against an extremely unfair playing field. Many current trade agreements are heavily weighed against U.S. manufacture. While I appreciate your point on education, it is actually a naive conclusion that, “free trade creates more opportunities for everyone, not just the business owners. If the production jobs go away, the increased trade should help expand the retail market.” Retail is built on extremely thin margins and creates few jobs for the middle class. Read this article, http://edition.cnn.com/2008/LIVING/12/05/unemployed.sign/index.html This demonstrates how even managerial jobs are lost to free trade. My father-in-law is an R&D engineer who lost his job the day NAFTA was signed by President Clinton. His company shutdown U.S. operations to increase manufacturing in Mexico and move R&D to India and China. The long-term damage is just now being seen and will only increase. Unfortunately pure Free Trade is simply not Fair Trade. We need to find a common-sense approach that protects industry, consumers, the environment, and those who are exploited by the unscrupulous.

    Bottom-line: Don’t buy either party’s line on this topic. There is so much money involved and in my opinion the threat is to the middle-class. Democrats want to destroy it to insure their power, and Republicans don’t always have the middle class’s back.

    I’d love to address your minimum wage topic. Maybe another blog.

    • Drunk C Video
    • August 4th, 2009

    hh… funny

    • kenton
    • December 28th, 2013

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    • Shiela
    • April 2nd, 2014

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