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Richmans' Trade and Taxes Blog
Free Trade Policy Is Not Good Economics
As Prof. Milton Friedman has written, “Ever since Adam Smith there has been virtual unanimity among economists, whatever their ideological position on other issues, that international free trade is in the best interests of trading countries and of the world.” I disagree with my former mentor but that there are circumstances when free trade is a suicidal policy, as is currently the case with the U.S. A Keynesian, Prof. Alan Blinder of Princeton University, is quoted as having written as recently as 2007: "Like 99% of economists since the days of Adam Smith, I am a free trader down to my toes." This is a foolish observation since the trade deficits that the U.S. was experiencing when he wrote had converted the U.S. from the world’s leading creditor to the world’s leading debtor and caused the loss of millions of U.S. jobs in manufacturing. These statements reflect discredit on the economics profession which asserts that Economics is a science.
There are circumstances in which free trade is a country’s appropriate policy, e.g., when the conditions for a free trade policy exist, namely a common currency and free movement of labor and capital. These conditions hold among the states of the USA so free trade is an appropriate policy for the USA. But where these conditions do not exist, free trade is likely not to be a good policy. Prof. J. M. Keynes must have been among Prof. Blinder’s one percent of economists who question free trade as an appropriate policy.. He wrote that when a trading partner uses mercantilist practices to keep trade unbalanced in its favor, he would recommend that Britain take counter-measures.
One of the effects of so-called free trade agreements, as Prof, Schott of Yale University has pointed out, is that U.S. manufacturers are encouraged to move their production to factories overseas secure in the knowledge that they can import their foreign-produced products duty-free. Economists have assumed, contrary to fact, that consumers always benefit from the lower prices of imported goods. They often do. But there is little evidence that the American consumer benefits at all from the re-location of American factories abroad. The prices charged by Apple, Nike, Hewlett-Packard and hundreds of others who have located their factories abroad are as high as they would have been had the products been produced in the U.S..
Only when a country experiences a balance of trade is free trade an appropriate policy.
Economics, as a science, can tell you what the effects will be of free trade in a given set of circumstance. Most examples in text books of the effects on trade tell you that if one country imposes tariffs or other impediments to trade, the other is advised not to retaliate but to assure a balance of trade. With balanced trade all trading partners benefit but not as much as they would if there were no impediments to trade. That is the case for free trade but the required conditions must exist, namely, a common currency and free movement of labor and capital.
Countries may benefit from unbalanced trade for a period of years. This is the case of developing countries which experience trade deficits while foreign direct investment – investment in factories and equipment – is taking place in their countries. These direct investments benefit them while the investment is taking place and with increased job opportunities when the factories start operating. Of course, as the Asian Tigers learned, financial investment is not direct investment and may not be beneficial at all.
The U.S. policy of free trade has raised corporate profits of multi-nationals while causing the loss of millions of manufacturing jobs. The trade deficits have been a drag on economic growth. Economists attribute the decline in U.S. manufacturing as a percent of GDP to trends toward the consumption of services. But the reality is that the U.S. is the leading consumer of industrial products in the world. The reality is that much of the manufactures we consume are made abroad.
Free trade is always an appropriate policy when trade is in balance, as my colleagues and I pointed out in our book Balanced Trade (Lexington Books, 2014). And we point out that balance is easy to achieve without the intervention of international organizations, which never or hardly ever support the U.S. in its disputes with other nations. We proposed a single-country-variable-tariff, which we call the “Scaled Tariff”, which would be imposed when a country experiences a chronic trade deficit with an important trading partner. For example, the U.S. has been experiencing chronic trade deficits with China, Japan, and Germany. These deficits may or may not be the result of their employment of mercantilist practices, trade barriers, subsidies to exporters, manipulation of exchange rates, etc.. But there is no need to prove it is the result of illegal practices. We need to balance trade. The scaled tariff rises if the trade deficit increases and disappears when trade nears balance.
Announcement by the U.S. that it will impose the scaled tariff will have an additional beneficial effect. Firms that relocate their factories abroad will be put on notice that if they invest in a country with which we are experiencing a chronic trade deficit, their imports from their factories located abroad may be subjected to the scaled tariff. This may tend to offset the encouragement to located factories abroad which exists currently.
Many journal articles have been written by economists showing that when other countries impose tariffs, employ non-tariff barriers, manipulate exchange rates, trade is still beneficial so long as trade is in balance. Of course, all would be better off if there were fewer barriers to trade and trade was in balance.
Journal of Economic Literature:
Atlantic Economic Journal: