by Kenneth Zapp, PhD
IN 2006, a survey of American economists found that 87.5% of them supported “eliminating unnecessary tariffs and other barriers to trade.” Currently, Donald Trump and Bernie Sanders who seem to agree on little else, claim that free trade is harmful for our economy in general and our workers specifically.
Understanding how this is possible may be the first step in finding our way out of this mess.
The theory of trade is seductive. Trade forces countries to specialize in products for which they have comparative advantages such as resources, climate, and knowledge. When this happens the globe’s scarce resources are used most efficiently and all countries which engage in trade maximize their incomes and their citizens’ wellbeing.
Trade brings a new diversity of products into a market but even more relevant today price competition into our markets. With less trade, inflation will only increase.
The theory also provides mechanisms which resolve short-term trade imbalances without the need for governmental interference in trade flows such as tariffs, quotas, embargos (limits on goods entering or leaving a country) and currency exchange rate manipulation.
Flexible exchange rates help a country which experiences a short-term negative trade balance to increase their exports and reduce their imports as the demand for its currency falls. Its goods become cheaper and imports more expensive, thereby restoring its trade balance.
The theory goes on to explain that a country with a trade deficit will counter this financial effect by borrowing funds from those with trade surpluses, thusly restoring a global balance, again without needing a governmental response.
The intellectual beauty of the theory’s benefits and self-regulating mechanisms elevated it to a canon of sophistication: only the simple thinkers challenged its tenets.
Among its adherents were Presidents Clinton and Obama and all the Republican leaders since the great depression until Trump.
In 1994 the NAFTA established a market of almost 400 million consumers among us, Canada and Mexico with virtually no trade barriers. During its first year our trade with Mexico was balanced.
Fifteen years later we had a trade deficit of almost $100 Billion with our southern neighbor. With these deficits, American workers lost jobs.
A story among economists may provide some insight into the gap between our theory and the NAFTA result: An economist was asked why his development plan for an emerging economy failed. He answered that the theory was correct but the conditions were wrong.
The theory of free trade was first articulated in the late 18th Century and then fully developed during the 1800s. During this period it was never envisioned that an underdeveloped country where people worked for less than a dollar an hour with no safety or environmental regulations could manufacture products to compete with developed nations.
The power of theory within the discipline of economics became even clearer to me during an annual conference of the American Economics Association. Having been recently appointed Honorary Consul for the new Republic of Slovenia, I reported to a session of the conference about behavior of workers who continued working even though their firms could not pay them.
A young PhD rose and said that no accepted economic theory explained this behavior and therefore he could not accept my report. Theory first!
Today, the realities on the ground do not match the assumptions of the theory. Again, the theory was correct but the conditions wrong. Immediately after NAFTA’s implementation, thousands of American firms opened manufacturing operations across the border where wages and regulations were low.
Sadly, this was not free trade but unfair trade. This trade was and is harmful to American workers while it lowered the prices for American consumers
Where conditions on the ground match the theory's assumptions the predicted benefits of trade are realized in general. If we import beer from Denmark or cars from Canada where wages and regulations are abundant, the results are positive with one exception.
Trade, even when beneficial, can cause harm for people whose livelihoods are damaged by it. Trade theorists work in the aggregates and often underestimate the micro level pain of job loss and community disintegration.
This explains why people who are hurt by trade feel abandoned and mount political fights against it. Consequently, government should alleviate this pain by offering services such as job training and relocation funds.
But how may we trade with countries whose living standards are abominable without having our standards lowered? In the long run we should invest into fields we enjoy a knowledge advantage.
For example, Boeing became the world’s largest producer of airplanes partially due to research and development funds they received from the Defense Department. We should invest in knowledge based industries so that our people are doing work that others in less developed nations cannot.
Otherwise, free trade agreements with developing countries must be avoided or at least evaluated for their negative impacts on our living standards.
Tariffs in general are the worst response to trade imbalances. Have we forgotten the disaster of the 1930 Smoot Hawley Tariff Act?
While it claimed to protect American farmers and manufacturers from competition early during the depression, instead it sent the economy in a downward spiral which took a decade to correct.
Economically, general tariffs are the worst solution to a trade problem. They always evoke retaliatory responses from trading partners which hurt everyone.
They reduce competition and therefore increase inflation. They cause uncertainty in markets which in turn reduces job creating investment.
During the 1970s Congress gave the president sweeping authority over tariffs. Proponents, however, never anticipated the recent erratic tariff actions of President Trump. Also, the legislation did not define what constitutes an emergency and this will have to be resolved by the courts.
It may be time for Congress to reassert its Constitutionally based role in these decisions.
Kenneth Zapp, PhD, is a Professor Emeritus, Metropolitan State University, Saint Paul, MN