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Required Reading, Michael Lind's "The Cost of Free Trade"
Raymond Richman, 12/4/2011

Every once in a while, we read an article or a commentary that we believe should be called to everyone’s attention. If you want to know why the U.S. went from being the world’s leading creditor to leading debtor in three decades, we are unable to recommend anything better that Michael Lind’s superb article in The American Prospect on December 1, 2011( entitled The Cost of Free Trade. Mr. Lind is policy director of the Economic Growth Program at the New America Foundation. He describes the politics of free trade and protectionism from the founding of the republic, how politicians in both the Democratic and Republican parties not only allowed but encouraged the deindustrialization of the U.S., and how all the presidents since WWII, Republican and Democrat, sacrificed American industry and American workers to achieve international political objectives and continue to do so to this day.

Every citizen should be aware of this history. But knowing how it all came about and developing policies to correct the situation requires more than one article. We disagree with the policies the author recommends. We believe we have proposed on this site the correct policies to balance our trade and restore our manufacturing sector.  But his assessment of how and why we became the world’s leading debtor and how much it cost us is a pre-requisite for doing anything about it.

Lind argues that our international trade policies need to be reversed “both in general and in particular toward China.” We would include Japan and Germany as well. “Over the past two decades, leading U.S. manufacturers, both the venerable (like General Electric) and the new (like Apple), have offshored millions of jobs—by one recent estimate, 2.9 million—to China to take advantage of the cheap labor, generous state subsidies, and low currency valuation that are linchpins of China’s mercantilist development strategy.” In our view, China has been implementing a number of mercantilist (promoting exports and discouraging imports) policies in addition to those mentioned.

America in Lind’s view “could have preserved and promoted key industries and supply networks by creating favorable credit policies, tax incentives, local content rules, and tariffs to punish currency manipulation from countries like China.” We oppose mercantilist practices and we see no reason to imitate our adversaries. We have invented a simple mechanism, a variable single-country tariff that we call the “scaled tariff” whose rate falls as trade becomes balanced and rises as the trade deficit worsens.  (See our article in the Journal of International Law and Trade Policy, Nov., 2011).

Lind and many economists believe the Chinese yuan is undervalued. What is its correct value? Is the Japanese yen and the German euro undervalued? We have chronic trade deficits with both. We believe it is not necessary to force China to revalue the yuan when we have an easy legal way to revalue the yuan, the scaled tariff, a single country variable tariff. We believe we should apply the scaled tariff not only to goods coming from China but goods coming from Japan, Germany, and OPEC countries with whom we have chronic trade deficits.

In spite of the alleged undervaluation of the yuan, some countries have a favorable trade balance with China. They do not need a revaluation of the yuan. Because we have a trade deficit with China, we want to force all countries to change the value of their currencies vis-à-vis the yuan. Those who have a chronic trade deficit with China can employ the scaled tariff as we suggest that we do. It is a mechanism available to every country under the rules of international trade in our opinion.

While manufacturing as a share of employment declined in all nations, it declined least in countries with export trade surpluses like Germany (19 percent in 2008) and most in countries running large merchandise trade deficits like the U.S. (9.5 percent in 2008). He observes:

If ever a policy has been discredited by its results, it is the American trade policy of Democratic presidents Obama and Clinton, which is indistinguishable from that of Republican presidents Ronald Reagan, George H.W. Bush, and George W. Bush. Yet every president asserts that the next feeble and unbalanced trade treaty or two will turn America into an export powerhouse of the kind that it has not been for the past 30 years.

Pres. Obama, meeting with nations on both sides of the Pacific still makes that claim as he did when he signed the free trade agreements recently with Korea, Panama, and Colombia. As Lind writes, “The belief that greater liberalization of trade and investment must invariably benefit the American economy in the long run, no matter its short-term costs in terms of crippled industries and lost jobs, has become an article of faith for America’s bipartisan establishment for more than 50 years.” And, we would add, it could not be more wrong.

Lind writes, “In 2008, candidate Barack Obama, campaigning in Ohio, vowed: “I voted against CAFTA [the Central American Free Trade Agreement], never supported NAFTA [the North American Free Trade Agreement], and will not support NAFTA–style trade agreements in the future.’” The recent trade deals with South Korea, Colombia, and Panama are difficult to distinguish from CAFTA and NAFTA . Moreover, the Obama administration is pushing for a trans-Pacific trade agreement with countries on both sides of the Pacific.

Lind goes on to say that Obama is following the example set by Bill Clinton who promised to balance trade in his 1992 campaign but at the end of his two terms, he boasted of passing NAFTA and granting most favored nation status to China. Clinton asserted that “establishing trade relations with China would boost American exports there and that increased trade would foster China’s democratization…  It will open a growing market to American workers, farmers, and businesses. And more than any other step we can take right now, it will encourage China to choose reform, openness, and integration with the world.” Instead, we got an enormous trade deficit that grew to $800 million in 2008.

It was not always thus. Before World War II, the United States was one of the most protectionist nations in the world. Protectionism was one of the issues in the Civil War, the South as an exporter of cotton and other agricultural crops, favored free trade and low-priced imports. The Democrats favored free trade and Republicans the party of protection and they dominated American politics from 1865 to 1932. Franklin Roosevelt fiercely attacked Herbert Hoover for his support of the 1930 Smoot-Hawley tariff legislation, and “the accusation that Hoover wrecked the world economy by signing the tariff became part of Democratic partisan mythology.” The notion that Smoot-Hawley significantly worsened the depression is not supported by any evidence at all. As Lind points out:

U.S. exports were no more than 7 percent of gross national product (GNP) in 1929. Between 1929 and 1931, U.S. exports fell by 1.5 percent of GNP, while U.S. GNP declined by ten times as much—by 15 percent. The volume of world trade shrank by two-thirds from the last quarter in 1929 to the first quarter in 1933. The global decline in trade that came after the passage of the tariff was the result of a sudden, universal drop in demand, not of retaliation against American protectionism. A similar collapse in trade occurred in 2008–2009 at the beginning of the Great Recession, in the absence of tariff wars.

But the myth of Smoot-Hawley wouldn’t die. Vice President Al Gore stated in a debate in 1993 that Smoot –“was one of the principal causes, many economists say the principal cause, of the Great Depression in this country and around the world.” No reputable economist would say that. As Lind states, “Gore was merely invoking what had become holy writ among America’s internationalist policy elites who had directed national policy ever since World War II and who lived in fear that the U.S. would revert to its prewar isolationism and protectionism.”  

During the cold war, U.S. presidents “began using their power as trade negotiators to give other countries access to American consumer markets in return for supporting American military or diplomatic policies.” Lind stresses the importance of trade in international politics and our willingness to sacrifice American jobs to achieve foreign policy objectives. He recalls a statement by Pres. Dwight Eisenhower who argued that measures “which tend to drive away an ally as dependable as Great Britain … do much more harm in the long run to our security than would be done by permitting a U.S. industry to suffer from British competition.” He writes:

In 1963, President John F. Kennedy ... warned an AFL-CIO convention in Miami that protection of U.S. industry risked “driving potential trading partners into the arms of the Soviets.” In March 1964, a Johnson administration task force on foreign economic policy, anticipating the rhetoric of 1990s New Democrats, called for a “war on poverty—worldwide. … The whole country would be the gainer if, over time, we could shift resources away from textiles, shoes and other unsophisticated manufactures into more advanced items where we have a comparative advantage … [such as] capital, scientific and technological research, skilled and educated labor.”

The crystal ball is often cloudy. Nearly every high tech consumer good that we buy is produced abroad, often by American companies that moved their factories overseas. As we have often pointed out on this site, high tech companies like Apple, Hewlett-Packard, Dell and many others have ten times as many employees abroad than they have in the U.S. and needless to say are proponents of “free trade”.

As Lind points out, the notion that countries like China are outdoing the U.S. in manufacturing because their educational system or their infrastructure is superior to that of the U.S. is erroneous. “In reality, Chinese mercantilism, like that of Japan, South Korea, and other Asian mercantilist countries, is based chiefly on currency manipulation and state-directed credit to targeted export industries and infrastructure. As long as countries manipulate their currencies and subsidize their industries, no amount of investment in American education and infrastructure is likely to improve America’s trade balance and reignite American manufacturing.” We are in full agreement and have said so on this site many times.

“Germany and Japan, where wages are comparable to those in the U.S., continue to run chronic merchandise trade surpluses with us for reasons having nothing to do with low-wage workforces and everything to do with those nations’ strategic industrial policies and the structure and governance of their corporate and financial sectors.”

Within the U.S., it is absurd to create factories capable of manufacturing only renewable--energy products.  But “such new industries as renewable technologies are no more likely to remain in the U.S. than the old industries, confronted as they are by subsidized Chinese competition.” The bankruptcy of Solyndra is a case in point.

Lind is outstanding in describing how we got into this mess. But he has no ideas for getting trade into balance except to pursue the same policies that China, Japan, and Germany used to get and maintain their trade surpluses with us.

He cites the some speeches by Democrats and Republicans wanting some action to be taken to balance out trade with China as evidence of growing support for “protectionist” policies, including the passage of a bill in the Senate to enable the president to impose tariffs on Chinese imports unless China allows the yuan to appreciate. The yuan has appreciated several times over the past few years as the Chinese have pointed out. Our trade deficit kept growing.

Lind’s argument that Washington has declined to develop anything resembling a national industrial and trade strategy, though “such things are routine among most of the nations we trade with.”  Surely Lind is not proposing that we employ similar mercantilistic practices. Let us take action but let it take the form of legitimate and effective counter-actions like our proposal for the imposition of a scaled tariff which would balance trade.

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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]