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 Richmans' Trade and Taxes Blog

The Case Against Free Trade
Raymond Richman, 9/15/2016

There is a very good case for international trade between two countries. Both countries can increase their welfare by exchanging goods that are cheaper to produce for goods that the other country can produce more cheaply. Both countries benefit. Historically, economists called this the law of comparative advantage. But for a country to benefit from international trade, its trade must be in balance with the rest of the world unless the imbalance is temporary; for example when the imbalance permits the import of capital goods that will enable it to produce goods that will enable it to balance its trade in the future.

Few goods are directly exchanged for other goods. Goods are usually exchanged for money. In international trade, goods are paid for in any currency the seller with accept. Historically, this meant exchange of goods for gold or other precious metal. For many decades, most currencies were on the gold standard, meaning their currencies could be exchanged for gold. From 1880 to World War I, most countries were on the gold standard and it was a period marked by economic growth in most countries. A so-called gold-exchange standard succeeded it in which the U.S. was on the gold standard and other countries could convert their currencies into U.S. dollars or gold. But it broke down when the U.S. abandoned the gold standard in 1971. Since then, most imports have been paid for in U.S. dollars, internationally  accepted as a reserve currency. The U.S. dollar continues to be the preferred currency for paying for imports. But the U.S. dollar today has competition. Many international transactions are settled in other currencies, the Euro, or the currency of one of parties, the Chinese Yuan, for example, since China is a leading exporter and importer.

Most of the problems of international trade are related to the fact that a number of big countries have trade surpluses year-after-year, becoming international creditor nations. This has been described as a beggar-one’s-neighbor policy because it grows its own economy at the expense of lack of growth or slow growth in the economies of its trading partners. The U.S. has incurred annual trade deficits which became huge after conclusion of the GATT agreements and the creation of the World Trade Organization in 1995. The stagnation of the U.S. economy during the past two decades and the loss of millions of American manufacturing jobs can be attributed to the trade deficits. Today, China, Germany, and Japan are the leading creditor nations. And South Korea is becoming one.

Of course, countries do not need to balance their trade with every country but with the rest of the world. But this is not and has not been the U.S. recent experience. For two decades the U.S. has experienced rising trade deficits with the rest of the world. In 1980 the trade deficit was $13 billion or about 0.45 percent of GDP, less than one-half of one percent. As a result of the successive GATT trade agreements, the trade deficits grew enormously reaching $376 billion in the year 2000, diminishing GDP by 3.66 percent and contributing to the 2000-01 recession. The U.S. trade deficit grew to a record level reaching $723 billion in 2008 diminishing GDP by a record 4.91 percent and helping to precipitate the Great Recession of 2008-09. As a result of the Great Recession, international trade decreased and the trade deficit fell, recovering to $530 billion in 2015, reducing GDP in that year by  2.95 percent.

The following table shows GDP and Net Exports for selected years from 1960 to 2015.

                               Gross Domestic Product (Billions of dollars)

The Bureau of Economic Analysis of the Department of Commerce published the GDP figures so these facts could not have escaped the thousands of economists who saw nothing to worry about because they were the result of “free trade”, a dominant ideology in economics that has no scientific basis at all as we shall note below. And the data show that the stagnation of the U.S. economy, the decline in manufacturing and the resulting unemployment could have been avoided had the U.S. policy been one of balanced trade instead of free trade. The best of all possible worlds would be free and balanced trade.

What is the U.S. government’s goal in pursuing international trade agreements that have caused so much harm to the U.S. worker? Its announced purpose is to achieve greater welfare for all trading partners by reducing barriers to trade. Economic theory holds that all countries benefit when trade is balanced. The most important change in the economic theory of the benefits of international trade did not occur until economists began to realize that comparative advantages are not fixed over time but can change when producers in a country are willing to invest enough to acquire economies of scale in the production of a manufactured product that gives it a comparative advantage with respect to its trading partners at existing exchange rates. Profs. Ralph Gomory and William Baumol appear to have been the first to show this in their book, Global Trade and National Interest, Lionel Robbins Lecctures, 2001.

The spectacular growth of the Chinese economy to become the world’s second greatest manufacturing power especially after it signed a trade agreement with the U.S. in 1996 and joined the WTO in 2001 is proof of the Gomory thesis. China’s growth over the past two decades was due not only to the trade deficits but to the movement of factories from the more industrialized countries, especially the U.S., to China, an unintended consequence of the trade agreements.

The international trade agreements negotiated at the conclusion of the General Agreement on Tariffs and Trade not only resulted in huge trade deficits for the U.S. but provided that new products produced by any of the members shall be free of tariffs by any other. An unintended consequence was the movement of factories from the U.S. to its trading partners where their labor costs would be lower.

Why do countries become chronic trade surplus and trade deficit countries under free trade? There are a host of reasons. The principle causes are the employment of mercantilist practices by the trade surplus countries which limit their imports and promote their exports and the other is their under-valued exchange rates. These are decisions which any sovereign government can make. Trade agreements can prohibit or restrict the employment of mercantilist practices but do not attempt to fix exchange rates. Trade agreements also restrict a number of other sovereign rights. For example, under WTO rules a country may not require labels that incicate the country of origin of imports. And some require mandatory arbitration of disputes arising from the trade agreements.

Countries can protect themselves by applying single-country-variable tariffs, our invention the scaled tariff, in which tariff rates rise or fall depending on whether the trade deficit is increasing or decreasing. See our book, Balanced Trade (Lexington Books, 2014).

The U.S. trade deficits became an important issue in the 2016 campaign for the presidency of the U.S. when the candidate of the Republican Party, Donald Trump, registered his objections to unbalanced trade and the exodus of U.S. factories to foreign countries.

Free trade has no economic theory to justify the policy. According to current economic theory, free trade is only in the interest of a country if  1)all its trading partners impose no artificial barriers to trade, i.e., do not engage in mercantilist practices, 2) all allow their exchange rates to be determined in free markets, and 3) all allow the free movement of labor and capital. These conditions hold in the U.S., the European Union, and Great Britain.

Of course, if one believes that wages should be equalized world-wide, a case for a world-wide free trade policy can be made. Unfortunately, it would mean equalizing U.S wages downward.  

A case can be made to prohibit governments from making trade agreements. Governments are not producers of goods in a free-market economy. When  negotiating trade agreements, governments usually favor one sector or producer in the country, the favored sector or industry being one whose support the political parties seek. This has been given the name of crony capitalism. The private sectors of each country, all of the producers of goods in the country, are quite able to seek buyers of their products abroad. What advantage other than the freedom to move production abroad does a trade agreement give the private sector as a whole? It is true that trade agreements require its signatories to impose no new tariffs. The principal beneficiaries are the multi-nationals who are free to move without hindrance from one country to another among the trade agreement partners.