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 Richmans' Trade and Taxes Blog

Only the USA's Leaders Are Foolish Enough to Embrace Unilateral Free Trade
Raymond Richman, 10/12/2010

As every economist knows, the editors of the Wall Street Journal believe in free trade. They can be forgiven; they are not economists. But economists should not be forgiven. There is no economic theory that supports a unilateral policy of free trade. Yet most economists believe it is the best policy for the U.S. to follow. Free trade is an ideology, based on faith, not science.

In its weekend edition, 10-9-10, the WSJ features an article by Professor of Economics Douglas Irwin of Dartmouth College entitled “Goodbye, Free Trade.”  How distant the title is from reality is indicated by the fact that there is no such thing as free trade among nations and probably never will be. There is no free trade theory in any economics textbook. But every text decries mercantilism. We, too, decry mercantilism but we believe in balanced trade, not free trade. Economic theory shows that when trade is in balance all the trading partners benefit.

Every country has some trade barriers. America’s barriers to trade are among the lowest in the world and the lowest of any large country. The U.S. Constitution forbids the states from imposing tariffs or interfering with the free movement of citizens and the free movement of capital among the states. Those are the conditions required for a free trade policy, no barriers to trade, or to the movement of capital, or to immigration.  Ever since the classical economists, Adam Smith and David Ricardo, condemned mercantilism, U.S. economists have preached free trade and to turn the other cheek if other countries employ mercantilist policies.

The typical defense of free trade given by most economists when asked what they would do to reverse chronic trade deficits is “If your trading partner is foolish enough to ship goods to you in exchange for paper, why should you object?”  Prof. Milton Friedman said that to me sixty years ago at the University of Chicago and Prof. Allan Meltzer of neighboring Carnegie Mellon University wrote that to me this year. But they did not consider the consequences of chronic sizeable trade deficits. We have endured  the loss of hundreds of factories and millions of manufacturing  jobs. Turning the cheek is fine for university professors with tenure but not for the workers who lose their jobs, for the owners of factories forced to close, and for workers in general who are condemned to lower real wages because economic growth is retarded.

Germany and Japan, former enemies, grew their economies post World War II  by engaging in mercantilist practices, deliberate policies to restrict imports from and stimulate exports to the U.S. They gained annual trade surpluses with us of tens of billions of dollars annually. Let’s hope they do not again try to conquer the world.

China became hostile to us when it embraced Communism after deposing Chiang Kai Chek. The Chinese communist leaders, to their credit, recognized that Communism was not a productive economic system so they gradually allowed farmers, then shopkeepers, then manufacturers to practice (that is to play at) being capitalists. Then they allowed foreign capitalists to locate their nominally privately owned factories in China provided they had Chinese partners. Nominal? Of course, even before war breaks out between China and the U.S. (or even before the U.S. capitulates as is more likely if we continue to practice unilateral free trade), China will declare those factories Chinese just as we declared German factories in the be American when Germany declared war on us in 1941.

The damage done to U.S. workers and the U.S. economy by the chronic trade deficits has finally been recognized. But American economists attribute the deficits to an overvalued renminbi (the Chinese yuan). So we are foolishly engaged in trying to pressure the Chinese into revaluing their currency. The dollar has declined 50 percent against the Euro since Jan 1, 2002 but Germany still has a sizeable annual trade surplus. Clearly, Germany has succeeded in maintaining a trade surplus with us in spite of the dollar’s loss of value relative to the Euro. The same is true of China.

As reported in Today On Line, 10-12-10, a leading Chinese economist, Yu Yongding, currently President of China Society of World Economics, and a former member of the monetary policy committee of the People's Bank of China, had this, inter alia, to say about the prospect of a revaluation of the renminbi: “It is hard to argue that the renminbi is not undervalued, given China's large and persistent current-account and capital-account surpluses.” But he does not believe renminbi appreciation will achieve the goal of bringing trade into balance. He writes, “… the effect of currency appreciation on the trade balance should not be exaggerated. The renminbi appreciated by 18.6 per cent in real effective terms, and by 16 per cent in dollar terms, from June 2005 to August 2008. Yet, from 2006 to 2008, China's annual exports grew 23.4 per cent, outpacing import growth of 19.7 per cent.”

Notice, he made no mention of free trade. Unilateral free trade is strictly a sin of American economists. Unilateral free trade is an American policy only. British economist John Maynard Keynes wrote that if trade threatened the jobs of English workers, he would recommend government intervention. In his 1937 magnum opus The General Theory of Employment Interest and Money, he devoted an entire chapter to his growing understanding that mercantilism works for the mercantilist countries and hurts its victims. When he tried to set up institutions after World War II, they were to be based upon balanced trade, not free trade.

We have long argued that revaluation of the renminbi would do little to bring trade into balance. What we recommend is not a tariff on specific goods applicable to all our trading partners but “scaled” tariffs applicable to those trading partners  with whom we are experiencing large chronic deficits. The scaled tariff applies to all imports from the offending country and begins low but escalates when the trade imbalance fails to improve.  Economists including Nobel prizewinner Paul Krugman have proposed a 25% tariff on all China imports to compel China to revalue the renminbi.

We consider his proposal to be foolish because it is aimed at the wrong goal. The tariff system should be aimed at balancing trade, not changing the exchange rate between the dollar and renminbi. Under WTO rules we can impose a scaled tariff whose rate depends upon the size of the trade deficit. It only affects our trade with countries with which we are experiencing chronic deficits. While trade is being balanced, we shall earn substantial revenues. A revalued currency will not only have little effect but will yield no revenue at all.

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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]