The Bear’s Lair: The Free Trade Scam

The Davos leaders last week bemoaned increasing protectionism, attacking opponents of globalization as economic illiterates. Yet there seems no reason a priori why trade should be less subject to tax than any other human activity, and with today’s gigantic governments the need for revenue is very real. Free trade benefits some countries much more than others; today, even without extravagant cheating, it is an unnecessary handout to China’s thoroughly unpleasant regime. A balanced polity, global as well as national, is at least somewhat protectionist.

The theoretical economic arguments for free trade are spurious. Yes, of course it would be lovely if goods and services could flow freely all over the world, without suffering tariffs as they did so. It would also be lovely if goods and services could flow freely all over the world without onerous documentary and regulatory requirements. But in the real world, full of real people, an entirely unregulated flow of goods and services would result in a “race to the bottom” of standards and universal child labor – that, after all is what an ethos of rampant cost minimization at the expense of all else would achieve. Completely free movement of goods is as unattractive an ideal as a universal world government or completely free movement of people; it is a policy suited only to robots and works appallingly badly when real, fallible, indifferently-behaved human beings are involved.

There is also the problem of revenue. All governments must be paid for. In the 19th century, William Gladstone dreamed of a world with completely free trade and no income tax – to him, both tariffs and income taxes were messy compromises. Even in Gladstone’s time, government had to be paid for, and without either tariffs or income taxes, paying for even the minimalist government Gladstone wanted would have been very difficult.

In any case, the gap between high ideals and loathsome reality was even more yawning for Gladstone than it is for the rest of us. He could afford to go into politics only because his father Sir John Gladstone had been an immensely successful slave trader, receiving £106,769 from the Slave Compensation Commission after the 1833 abolition of slavery, the largest sum paid out by the Commission. As for his private life, outwardly a model of marital probity, it appears to have involved “rescuing” prostitutes who then provided him with flagellant services.

Retiring hastily from the subject of Gladstone’s private life, we should consider next who benefits from an energetic free trade policy. As with most economic questions, this was well addressed by Lord Liverpool in his free trade speech of May 26, 1820:

“The cotton manufacture, for instance, in which we have acquired so great a superiority over other nations, need not fear any thing from an abolition of all protection.”

As Liverpool perceived, global free trade is hugely beneficial to those countries that have established a monopoly over the most efficient technologies, or through huge reserves of labor and technology “borrowing” have given themselves an unbeatable manufacturing cost advantage.

In Liverpool’s world, that was Britain itself; first in cotton textiles, and later spreading further as mechanization increased. This had been seen in action as early as 1787-92, when efficient British textile manufacturers had invaded the French market following the 1786 Eden Treaty, intensifying both French economic distress and French hatred of Britain just in time for the Revolution and a 22-year war. Later, Britain’s free trade advantage in international markets in a rapidly growing universe of products was further expanded by Sir Robert Peel’s 1846 abolition of Liverpool’s Corn Laws. This allowed British employers in sweatshop industries to squeeze wages further, owing to the lower cost of food and a surge in distressed agricultural workers seeking factory jobs. Until 1861-62, while other countries remained generally free trading, Britain’s pursuit of free trade, culminating in the 1860 Cobden-Chevalier Treaty with France, gave it an immense advantage in seizing new markets for its efficient manufactures.

The United States, under the Republicans who followed President Lincoln and the 1861-62 Morrill Tariffs, had no such manufacturing advantage – initially Britain was highly competitive with the U.S. and later Germany and even France became so. Hence the country opted for protectionism, developing heavy industry behind high tariff walls and thereby allowing American manufacturing wages to rise far above those of its competitors. Only in the decades after 1945 was the United States close to a monopolist in modern manufacturing industry, at which point, realizing its (temporary) advantage, the country switched to ardent advocacy of free trade. Britain alas, having lost out through unilateral free trade from the 1870s onwards and only rescued itself through the Imperial Preference Ottawa Agreement of 1932, was foolish enough to allow the United States to bully it into abandoning Imperial Preference. This condemned the country to inferior economic performance, followed by half a century trapped in the high-cost European Union.

Just as Britain was too slow to abandon free trade after other countries surged towards protectionism after 1860, so the United States dallied too long with the free trade chimera after the 1991 collapse of the Soviet Union. This allowed the inordinate growth of the new manufacturing superpower: China. Unlike Britain in 1820 or the United States in 1950, China does not have superior technology, but through massive foreign investment and a certain amount of intellectual property theft it has built its manufacturing technology to be just as good as its competitors’ and often more modern. What it does have is an immense workforce, now educated close to Western standards, but with wage levels a quarter or less of those in the West. Consequently, the massive winner by free trade is now China, the dominant world manufacturing power. Like early Victorian Britain and the 1950s United States it can use the immense strength that free trade gives it to assert at least a measure of global political and military dominion.

Free trade is thus very dangerous to the Western geopolitical position and indeed, since China is a nominally Marxist dictatorship, to the world’s freedom in general. However, it is also damaging from a purely neutral economic viewpoint. Since Gladstone’s time, governments worldwide have undergone an abominable bloat, now absorbing almost half the economic output in most countries, compared to the 10% or less of economic output they absorbed then. This bloated and unproductive activity (much of which, of course, relates to transfer payments) must be financed somehow.

The Liverpool-era taxation system, focused largely on sumptuary taxes on luxury goods and manservants, is nowhere near sufficient to finance Leviathan. Income taxes, if forced to finance the system alone, become impossibly onerous and damaging to innovation, preventing even able people from acquiring the modest levels of seed capital that can be used to start a business. That explains the low level of entrepreneurial activity and innovation in the European Union, where income tax levels are high and are supplemented by massive social security taxes and value added taxes on domestic production and imports.

Those VATs already break the free trade principle by being rebated on exports, so that if similar products are manufactured in the United States and Germany and there are no tariffs, the U.S. product is 20% or more costlier in Germany than the German product is in the United States. However, the system can become truly balanced, and revenue raised for the bloated governments, if moderate tariffs are imposed everywhere on imports, taxing foreigners rather than domestic producers, affecting international trade but allowing income taxes to be reduced. In such a system, innovation is maximized, and manufacturing activity no longer flows irretrievably to China.

One final benefit of tariffs is a useful frictional effect, in a world that is no longer on the admirable Gold Standard but instead is subjected to floating and often wildly fluctuating exchange rates (in the past decade, for example, the yen/dollar exchange rate has fluctuated between 90 and 150 yen to the dollar). Free trade with floating exchange rates causes random bankruptcies of exporters rendered uncompetitive by a sudden rise in the exchange rate, throwing people out of work who would still have their jobs if exchange rates were normalized at an average level. A moderate tariff adds a necessary friction to world trade, avoiding these unnecessary “menu-changing costs” that involve serious hardship to those affected.

Free trade is thus a chimera, that should be avoided for the long-term benefit of all. Free movement of labor, with the massive population surges that are damaging living standards in most Western countries, is even more destructive, because it brings job-destroying competition right to the worker’s doorstep, so that even personal services such as hairdressers are affected. As for global government, as dreamed of by Klaus Schwab and the WEF, that is the worst nightmare of all, as we will find out if we are ever forced into it – and if we are forced into it, we may well have no way out.

“Patriotism is the last refuge of a scoundrel” according to Dr. Johnson, but nationalism and moderate protectionism are staunch bulwarks of freedom for sensible people desiring a world of peace and prosperity.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)