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Economics Does Not Favor Free Trade; It Favors Balanced Trade.
Raymond Richman, 7/10/2015

Economists have been virtually unanimous in their belief that the policy of free trade benefits all trading partners since Adam Smith endorsed the policy of free trade in his famous work, the Wealth of Nations. At that time, countries were pursuing a policy of building up gold reserves by exporting more they import, a policy called mercantilism. A policy of free trade was a revolutionary idea at that time in opposition to the mercantilist practices of that time. But today, a policy of free trade is a suicidal policy for a country. The only policy that economic theory justifies today is a policy of balanced trade with the rest of the world which can be shown to be beneficial to all trading partners. About the only case in which free trade in an appropriate policy in the long-run is when both trading partners employ a common currency, there is free movement of capital and labor, and there are no trade barriers. These conditions hold among the States of the USA in their trade with one another.  

Under current economic conditions free trade is a suicidal policy as the recent history of the U.S. demonstrates. The U.S.A. has experienced chronic international trade deficits for decades, which have converted the U.S. from the world’s leading creditor nation to the world’s leading debtor nation, decimated its manufacturing sector, and caused the loss of millions of U.S. jobs in manufacturing. Prof. J. M. Keynes was a realist when he wrote that when a trading partner uses mercantilist practices to keep trade unbalanced in its favor, called a beggar-ones- neighbor policy, he would recommend that Britain take counter-measures. We suggest a counter measure that any nation could use under World Trade Organization rules, the Scaled Tariff, a single-country-variable-tariff, whose rate rises as the trade deficit increase and disappears as trade becomes balanced.

The only trade situation that economists are, and should be, in unanimous agreement as beneficial to both parties is balanced trade. Economic theory for a century has recognized that even when a country uses mercantilist practices, if trade is in balance all trading partners benefit. Many journal articles have been written by economists showing that when other countries impose tariffs, employ non-tariff barriers, and manipulate exchange rates, trade is still beneficial so long as trade is in balance.

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 that consumers always benefit from the lower prices of imported goods. There are two things this view ignores. Firsts, consumers are also producers. They may benefit as consumers but lose as producers. And second, not mentioned is that 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.

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. As suggested above, we propose 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 for decades. 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 locate factories abroad which all existing trade agreements encourage. 

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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]