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 Richmans' Trade and Taxes Blog

How the False Doctrine of "Free Trade" is Crippling the U.S. Economy.
Raymond Richman, 6/16/2010

It is no secret to our readers that the U.S. has been experiencing enormous growing chronic trade deficits for two decades that converted the U.S. from the world’s leading creditor to the world’s leading debtor. Our political leaders, Republicans and Democrats, and their advisers ignored the awful consequences of the growing trade deficits and they continue to do so. These deficits cost the U.S. millions of  well-paying industrial jobs to foreign "competition". The workers who lost their jobs were forced to seek employment in other sectors of the economy. They found jobs at lower wages. Their competition for jobs depressed wages generally throughout the economy. The result has been wage stagnation and a worsening of the distribution of income observed in the U.S. during the past two decades.

On this site and in our book, Trading Away Our Future (Ideal Taxes Assn., 2008) we condemned the American economists’ infatuation with free trade, a legacy of Adam Smith’s 1776 criticism of mercantilism. Mercantilist practices – barriers to imports and subsidies to exports – are rightfully to be condemned but we find nothing in the economic literature that justifies free trade as an appropriate response to the mercantilist practices of our trading partners. To be sure, free trade is an appropriate policy between the states of the United States which enjoy a common currency, a common tariff, and the free flow of capital and labor as the U.S. Constitution obliges the states to do. The European Union Treaty of 1992 (Maastricht Treaty) obliges its member states to use a common currency and imposes common tariffs, and allows capital to flow freely among its members. But it lacks any obligation to allow the free flow of labor and makes no provision except budget austerity to balance trade. Thus, Germany experiences chronic trade surpluses while Greece, Portugal, and Spain experience chronic trade deficits. The latter countries are in difficulty because their debt is expressed in euros and they are unable to earn enough euros to service their debt. The U.S. has experienced  growing trade deficits for decades and would long ago have defaulted on its debt were it expressed in gold or foreign exchange rather than dollars which it can simply print. (Poor Greece, it cannot print euros.)

The data in the following table appeared every year in the Annual Report of the President’s Council of Economic Advisers. And every year, the Council took pride in the growing level of international trade, ignoring the fact that our imports were growing faster than our exports. Economists found all kinds of excuses for accepting the trade deficits. They asserted correctly that it is natural for manufacturing to become a smaller proportion of a country’s income as a country’s economy grows. But a growing trade deficit is not a natural result of growth; Germany and Japan have chronic trade surpluses! So has China. They assert that the development of highly sophisticated technologies requires highly educated workers and that our educational system has fallen behind and is not producing enough skilled workers. But the highly sophisticated goods we import are not produced by workers more highly educated than ours. They are simply not paid as much.  Moreover, the sophisticated goods that we import are often invented here but the owners of the patents chose to manufacture them abroad. The most recent example is Apple’s I-pad, which is produced for Apple in China.

How could our leaders and our academics have ignored the data that appear in the following table and their negative implications for our workers, our industry, and our economic power?  A number of reasons suggest themselves. It is because they believe that trade benefits all trading partners, even unilateral free trade. Since 1945, nearly all of our leaders and academics have been globalists. We created institutions like the UN, the World Bank and regional banks like the Latin American Development bank, the International Monetary Fund, Unesco, the General Agreement on Tariffs and Trade which grew into the World Trade Organization, and the World Health Organization, et al. To raise living standards around the world they believed required the U.S. to lead and to show the way. The U.S. was the only major power to have survived WWII stronger and richer than before the war. The American elite thought that was the way it would always be.

How could labor leaders have ignored them? One  answer is that the bulk of unionized workers are government employees who are immune from foreign competition and enjoy the benefits of low priced imports and many others are engaged in domestic industries free of international competition such as those in the  construction industry.

US International Trade in Goods and Services, 1992 - 2009

                             (Billions of dollars)

          Source: US Bureau of Economic Analysis

The declines in export, imports, and the trade balance in 2009 reflect the effects of the worldwide recession and the millions who lost their jobs and their savings. (But see the table below which contains surprising data for the first four months of 2010.)

What are the chances that market forces will eliminate the trade imbalance? None at all. Chairman Bernanke is on record as stating that market forces will not correct trade imbalances so long as foreigners and foreign governments continue to invest their savings in U.S. domestic assets. We would prefer to say “as long as our trading partners invest their trade surplus in U.S. domestic assets. At the G-20 meetings in London and Pittsburgh in 2008 and 2009 showed, countries will talk about balancing trade but will do little or nothing to bring it about.

Our attempts to induce China to allow the yuan to appreciate have so far come to naught. Prof. Krugman has called for the U.S. to bring pressure on China to allow the yuan to float by levying or threatening to levy a 25% tariff on imports from China. We have called for tariffs on all countries with which we are experiencing chronic trade deficits (a sure symptom of mercantilist practices) large enough and long enough to bring trade into reasonable balance.

The following table shows that the economic recovery the U.S. has made thus far in exiting the recession has not succeeded in closing the trade balance with China. Indeed, there is considerable evidence that China will not abandon her mercantilist strategy. It has resisted pressure to allow the yuan to rise in value relative to the dollars which would have the effect of making Chinese goods more costly to American and American goods cheaper to Chinese consumers. We do not believe that this would tend to reduce the trade imbalance because for all practical purposes Chinese purchases of foreign goods are controlled by the government.  

US Trade Balance With China,  Jan. to Apr. 2008-2010

(Millions US$)    

Source: US Bureau of Economic Analysis

During the first four months of 2010, the U.S. trade deficit was nearly the same as it was during the first four months of 2008, with no improvement in the balance of trade. One should have expected given the slow rate of growth of the US economy compared with the rapid growth of the Chinese economy that our exports to China would have increased and our imports decreased. What was the Chinese government doing to prevent its imports from rising as fast as the rate of growth of its economy? It must have been employing the same mercantilist practices it was employing in 2008, using formal and informal barriers to imports from the U.S. and subsidies to exports to the U.S. And what were we doing to stimulate exports to China? Just talking. When the recession ends, we can reasonably expect the trade deficit to widen

Under the rules that established the World Trade Organization (WTO}, countries experiencing chronic trade deficits are authorized to impose tariffs and other barriers to imports to bring its trade into balance. Isn’t that what we should have done a decade or more ago?  Oh no! Our leaders believe that that would be setting a bad example!

Comment by Jay Block, 6/31/2010:

Nice article.  You guys need to get your message out to a larger audience.  While the Dems/Unions have often talked about tarriffs and leveling the playing field there have been a handful of conservatives that have talked about it as well. 

Adam Smith may have been right for his time but, like you, I beg to differ.  In today's smaller, more connected world, it's easy all too easy to ship jobs off-shore. I suspect once America's colleges and University jobs start going "off-shore" then America's liberal professors will start asking for government protection as well.

Comment by Carlos Navarro, 2/14/2011:

Adam Smith would have agreed were he writing today.  For international trade to beneift all trading partners, the playing field must be reasonably level.  To counter China's state mercantilism, should we continue to trade with them, we must implement some mercantilistic measures of our own--subsidies, tariffs, tax breaks to local competing industries, etc.