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Book Review of Ian Fletcher's Important Book Attacking Free Trade
Ian Fletcher, Free Trade Doesn’t Work: What Should Replace it and Why (Washington, D.C.: U.S. Industrial and Business Council, 2010)
Edward Luttwak, Senior Fellow at the Center for Strategic and International Studies, writes in the Foreword “it is hard to imagine how America can rebuild its manufacturing and rebalance its trade, without repudiating free trade –to some carefully chosen extent. If nothing else, the need to neutralize foreign mercantilism demands this.” Ian Fletcher in this book proceeds to demolish the myth perpetrated and perpetuated by economists that “free trade” is good and protectionism is harmful. This is a must read book. It covers more ground than our book, Trading Away Our Future (Ideal Taxes Assn., 2008). We disagree with some of his arguments but applaud his attack on free trade which has cost the U.S. millions of industrial jobs, caused wages to stagnate, worsened the distribution of income, and contributed to the current economic crisis.
His introduction is entitled, “Why We Can’t Trust the Economists.” While admitting that all trade deficits are not bad, he castigates the huge U.S. trade deficits of 2006, 2007, and 2008 as obviously a critical problem and yet “Americans remain afraid to do anything about it.” Economists have made protectionism a dirty word and “so we remain paralyzed in the face of the crisis.” On the other hand, the trade deficits were not created by accident. “Foreign governments treat trade as war and use every trick in the book—legal and illegal under international agreements—to grab their industries a competitive advantage.”
The U.S. economy, he asserts, “has ceased generating any net new jobs in internationally traded sectors.” Economists with “wrong theories helped get America into its current trade mess, so we will need the right theories to get us out of it.” But, he writes, we need more than theories. Many economists are fully aware of the negative aspects of free trade “but support it over any likely alternative—which they fear would be worse.” They fear special interests will use protectionism to gain unjustifiable protective barriers. But he is optimistic. “Our government is sometimes corrupt and stupid, but it is also sometimes effective.” After all, foreign governments are subject to similar forces but many have learned to use tariff and non-tariff barriers to promote their country’s welfare. Not only Japan and China but Germany and many others.
He reviews and demolishes arguments frequently made for free trade. He argues that developing countries need protective tariffs to develop and, indeed, Britain and the U.S. were protectionist during their periods of rapid industrialization. Globalization has not made the nation-state irrelevant; the welfare of its citizens requires nations to impose limits on openness to trade. Industries can be wiped out or prevented from growing by foreign competition. Tariffs and non-tariff barriers are a fact of life and they are often used to gain an advantage over trading partners.
The author deals with the political arguments for free trade. Do the emerging countries have a right to impose trade barriers? Yes, but not to the point where it drags down wages in the developed countries. Moreover, it is clear, citing Brazil and China, that increased trade has often made the rich richer without benefiting the masses. And its effect in the U.S. has been a disaster for American factory workers. We do not need to choose, he asserts, between globalism and nationalism. Tariffs and non-tariff barriers are a fact of life. Fairly open trade most of the time is justified but absolute free trade is an extreme position. The same is true of unrestricted capital flows; they can weaken and endanger a country’s economy. Free trade as foreign policy does not lead to peace or expand human rights, citing China and other totalitarian nations.
Trade is growing between China and the USA. Unfortunately, the U.S. trade balance with China has been worsening for decades. It has had the effect of worsening the distribution of income and increasing the differences in the level of wages between the skilled and unskilled labor. The notion that even unbalanced trade is beneficial to both trading partners is nonsense. Savings to consumers do not create more benefits than the cost of wages lost. He lauds Paul Krugman and quotes him as saying US trade with the third world reduces real wages of many, and perhaps most, American workers.
He writes that it has been estimated that every billion dollars of trade deficit costs America about 9,000 jobs and that the deficit was costing us 1 per cent growth per year. The trade deficits have caused wages in the U.S. to stagnate, have weakened our nation’s security, and caused instability here and abroad. He argues that free market forces won’t resolve the problem. He has little faith in the ability of flexible exchange rates and argues that fixed exchange rates may be the solution.
We do not share his advocacy of fixed exchange rates. Indeed we believe them to be inconsistent with his argument that nation’s cannot be prevented from using formal and informal barriers to trade. Japan and China are good examples. Nobel prize-winner in economics, Paul Krugman, in a recent column in the New York Times, argued that the U.S. should impose an accross-the-board tariff on Chinese goods in order to pressure China into allowing the yuan’s value to rise, which would tend to reduce her exports and increase her imports. But what good would floating exchange rates do in the face of hidden non-tariff barriers. For all practical purposes, every Chinese import requires approval from the government.
Among proposed trade solutions that won’t work, Fletcher includes productivity growth, compensating the losers from trade, improving our educational system, and relying on our ability to be creative in the areas of software and pharmaceuticals. He writes that China has surpassed the U.S. in high tech competitiveness. Post industrialism won’t save us; “every $300 ipod sold in the U.S. adds $140 to our trade deficit with China” and of GM’s 11 design centers, only 3 are still in the United States. And high tech R & D increasingly moves offshore, citing the manufacture of HDTVs abroad. Boeing and others, he writes, are morphing into an assembler of European, Japanese, and Chinese components. By contrast Europe requires Airbus to outsource no more than 35% of its work. At work, also, he notes, are Japan’s, China’s, and European non-tariff barriers. He asserts that we won’t solve our trade deficit problem without doing the same.
He argues that we need imports and we need exports. Criticism of free trade, he writes, must focus on its economics, not side issues, like requiring a level playing field. Wages rise in trade surplus countries and fall in trade deficit countries. Nevertheless, it is a mistake to blame trade imbalances on different levels of wages. We must not concentrate on dying industries but on the harm the trade deficits do to still healthy ones and on winning tomorrow’s industries. These are keen observations.
He points out defects in the theory of comparative advantage which has been accepted by economists since David Ricardo enunciated it in the second decade of the nineteenth century. The theory was interpreted to mean that whenever relative differences in resources exist, mutual gains from trade must exist. In a sense, Ian Fletcher sets up a straw man. The theory does not explain and was not intended to explain, trade imbalances. Adam Smith and David Ricardo explained trade imbalances by the mercantilist practices, tariff and non-tariff barriers and subsidies, that governments pursued to secure trade surpluses. Fletcher is quite right that most countries historically engaged in mercantilist practices. And the latest practitioners, Japan, Germany, and China employed mercantilist measures to reap the economic miracles of their postwar growth. Fletcher writes that China “joined the WTO (and opened up its markets on paper) in 2001, after mastering the fine art of non-tariff barriers, largely with Japanese help.” “It has not even allowed foreign investors genuine property rights; it allows them plenty of profits for producing for export but no real ownership of corporations, land, or real estate.”
Fletcher has valuable insights on an extensive variety of international agreements. Every chapter displays his keen mind and sense of humor. Here is one:
The privatization of natural monopolies just substitutes private monopolies for public ones. Privatization is frequently no more than a one-time sell-off of future profits by the current government – with a cut of the proceeds going, of course, to its friends.
Another is a comment about the WTO which he states has consistently undermined U.S. interests by inventing new legal requirements that were never agreed to by the US. And his observation that between 1972 and 1990 fully half of the U.S. diplomats that left government service went to work for foreign governments!
More controversial is the solution he proposes. He begins by asking, “Where does growth really come from?” He quotes The Economist, "Economists are interested in growth. The trouble is that, even by their standards, they have been terribly ignorant about it.” Upgrading in one industry induces upgrading in others. Industries with increasing returns as a result of innovation, research and development lead the way. Productivity growth in agriculture lowers prices, in industry it does not.
One could quarrel with some of his analysis. Countries pursue as a matter of industrial policy growth strategies. The principal policies have been import substitution strategies and export-led development strategies. As we have written elsewhere, Japan and China and Germany have pursued both strategies simultaneously, with US industries their prime targets on both. The result, as Fletcher writes, is the deindustrialization of the US, which has been going on for decades as a result of the growth strategies of our trading partners. He decries state subsidies to prospective foreign-owned plants which merely shift production from one state to another at huge cost, $150,000 to $200,000 per job created. He provides example after example of the foolish policies emanating from Washington.
He acknowledges, as we do, the important breakthrough Profs. Ralph Gomory and William Baumol, in their book, Global Trade and Conflicting National Interests (MIT Press, 2000). They showed that whichever nation reaches economies of scale first becomes the lowest-cost producer and capable of suppressing competition. Fletcher asserts that the Ricardian contention that free trade outcomes are always the best possible is no longer tenable. As we noted above, this is a misreading of comparative advantage. What Gomory and Baumol showed was that comparative advantage can be acquired. Fletcher has that right; the question is what country gets comparative advantage in the right industries first.
His discussion of industrial policies is excellent. Protective tariffs are not enough; to achieve efficiency, the protected industry needs a stick as well as a carrot to make sure it does not abuse its tariff protection. He compares the industrial policies of Latin America and East Asia and why the latter succeeded and the former did not. And he shows that the US has a deindustrialization policy. He writes that the 2009 economic stimulus program “included money for every Congressional pork barrel under the sun” but very little for basic and applied research in areas, to name a few, such as energy conversion and storage, nano-manufacturing, and robotics.” He warns, “The U.S. will pay a serious price for this in the decades ahead.”
What Fletcher proposes is a Natural Strategic Tariff. He asks, “Can the flaws in free trade be fixed?” and then answers in the affirmative, proposing a flat tax on all imported goods and services. It would work, he says, because “Industries differ in their sensitivity and response to import competition.” A 30 percent tariff would not restore the clothing industry but would restore high-tech manufacturing like semiconductors. He makes a powerful argument for it.
Would the tariff violate the rules of international trade? If the tariff applies only to imports from nations with which we are experiencing chronic trade deficits, it meets the rules of international trade which are enforced by the World Trade Organization (WTO). Fletcher does not mention these rules. Nations are not permitted under those rules to take counter-measures, impose tariffs or subsidize exports in retaliation. The level and duration of the tariff would depend on whether and how quickly trade becomes reasonably balanced. Paul Krugman recommended a 25 percent tax on imports from China to pressure China into revaluing its currency. We believe that would not be enough to balance trade with China which has barriers against importation of any goods China believes it would produce itself.
Fletcher acknowledges that the sudden imposition of a tariff in the 25 to 30 percent range would cause instability in both countries which suggests that the tariff be phased in gradually. He suggests that domestic producers benefitting from the imposition of the tariff might take undue advantage of the protection they receive and become inefficient monopolies. He believes these problems can be dealt with.
Can the free traders be convinced that their opposition to tariffs is wrong in theory and practice? Can enough political support be obtained to implement the strategic flat tax on imports from countries with which we are experiencing trade deficits? Clinton and G.W. Bush were committed to free trade. And while Pres. Obama has not changed our policy, the trade deficits are becoming increasingly a political issue and there is greater awareness of the loss of jobs, especially to China but also to others.
Fletcher argues that the public is conflicted on free trade. He believes global warming may induce Americans to support tariffs on imports from nations that are notorious polluters, like China, as Paul Krugman has suggested. We do not share this optimism and are not even sure that there is any man-made global warming. Fletcher believes that the economic crisis is causing the Democratic left to think about protecting jobs, especially since the strongest free trade advocates are Republicans. He writes, “Obama is not going to be able to support free trade forever. Crisis will eventually come …”
However, we believe American multinationals now have a vested interest in free trade. Many of our largest corporations garner profits from outsourcing operations abroad and importing from their foreign-based subsidiaries. And they are large contributors to both political parties.
Comment by Jeremy Fox, 5/22/2010:
The assumption made by Ricardo and so many of his successors is that "comparative advantage" is static. In reality, it is highly fluid, capable of moving from country to country and region to region at the drop of a government subsidy, a new public investment, a currency devaluation, or a policy of keeping social and environmental standards as low as possible. Hence why centres of production move incessantly around the world in pursuit of cheap labour, cheap raw materials, local subsidies, lax regulations, and low taxes. What about people? Free Trade chews them up and spits them out again when their relative price goes up. Of course multinationals favour free trade! Their interest is corporate profit, not human welfare or the many responsibilities of government. Comparative advantage of the kind that operates in the modern world accrues primarily to them NOT to individual countries - a dichotomy that seems not to have occurred to the economic soothsayers who command the attention of Western leaders.
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