The United States and Chile signed a free trade agreement Friday; a similar agreement was recently signed with Singapore. I therefore thought it worthwhile to look at the issue of bilateral versus multilateral free trade agreements and, more broadly, to what extent free trade is what it’s cracked up to be.
Free trade, as an economic ideal, is rather like the stock market’s Efficient Market Hypothesis. It is helpful in indicating a general direction at which to aim, and it may be a useful principle in examining some of the more naked rent-seeking, but it can’t be fully implemented, and the theory behind it rests on some assumptions that are demonstrably false. The Efficient Market Hypothesis assumes instantaneous information transmission to infinitely smart investors, while the doctrine of comparative advantage assumes that all parties concerned are pure “economic men” with no irrational prejudices and no social costs for economic disruption or extensive retraining.
Imagine a world in which there was true free trade including (for labor is an economic value like any other) completely free movement of labor:
— Such a world would have permanent high unemployment, with consequent social unrest, in the wealthier countries. It would always be worthwhile for the more unemployable and desperate citizens of the Third World to find their way to the U.S. and Western Europe, because the expected return from their modest probability of finding work would be higher than their prospects at home. Of course, for those countries such as EU members with generous and open welfare systems, the net gain for unskilled immigrants, and consequent surge in host country unemployment, would be even higher.
— Nearly all manufacturing would migrate to the country with the lowest possible wage costs. This would hugely benefit the middle classes in those countries, at the cost of impoverishing blue collar workers in the West.
— Violations of the universal free trade principle would be highly profitable, for whichever substantial country violated it. If Japan, for example, kept immigration restrictions, while benefiting from the cheap goods produced elsewhere in the world, then it would have much lower unemployment, and consequently much lower social costs than other countries with higher immigration, with huge benefit to its economy.
— Poorer countries would earn a huge negative return from public education, as their more educated people migrated to wealthier countries to better themselves.
— Wealth would become highly concentrated in a few “gated communities” with good security, access to which would be the objective of all highly skilled persons worldwide. As far as possible, such communities would attempt to cut themselves off from the chaos around them.
Pretty unpleasant, isn’t it. Yet the overall principle of free trade, the doctrine of comparative advantage, whereby in a fully free market world manufacturing moves to those countries whose relative costs are lowest, and global wealth is thereby maximized, remains generally true. It’s just that the incentives to cheat on the system, and the non-economic costs incurred by applying it rigidly, are so enormous that the often modest comparative advantages are relatively swamped.
Nineteenth century Britain in 1846 adopted a purist free trade approach, abolishing nearly all tariffs on foreign goods and imposing only minimal non-tariff restrictions on the movement of goods and labor. The result was that within fifty years Britain had lost the world economic lead she enjoyed in 1846, to the thoroughly protectionist powers of the U.S. and Germany. In theory, the U.S. and Germany would have benefited from maintaining free trade with Britain. In practice, their tariff walls and other restrictions allowed them to build up industries that were able to earn higher returns and thereby undertake larger investments than Britain’s, which was exposed to the full blast of the global free market.
In agriculture, Britain abandoned agricultural protectionism, believing that the benefit of marginally cheaper food for the working classes outweighed the costs of depressed returns on agricultural investment. It worked fine for a couple of decades — until refrigerated transportation of meat and the opening of the U.S. railroad network brought competition that devastated the British agricultural economy, destroyed the social system that had served Britain so well, and left Britain within weeks of starvation in two world wars. Unilateral free trade proved to be like unilateral disarmament — suicidal in the long run.
In today’s world, the dirty secret about free trade is that trade is freest where the comparative advantage disparity is least. Agriculture is protected throughout the OECD, even though the workforce employed therein is now relatively small, because the comparative advantage of the Third World in agricultural products is huge. Textiles are protected by the multi-fiber agreement, because in such a labor intensive industry Third World producers would quickly drive U.S. and European workers out of a job if trade was freed. Automobile sales into the U.S. are free from Western Europe but subject to quotas from Japan and South Korea because Western European automobile producers are not particularly price-competitive with domestic ones. The U.S. signs free trade agreements with Chile and Singapore, but not Brazil or India, because the disruption caused by allowing Chile and Singapore free access to U.S. markets is minor. Immigration into the U.S. and the EU is freer for “refugees” lacking skills and able to carry out menial tasks than for highly skilled technicians, who might force down professional-class wage levels.
The prognosis over the next few years is for increased protectionism. The Doha round of free trade talks is going nowhere. It is likely to continue to go nowhere, because it involves trade issues such as textiles and agriculture where the Third World is extremely competitive, and such as intellectual property where the Third World will see a sizeable outflow of funds if it accedes to U.S. demands. This failure will be disguised by signing free trade treaties with minor players such as Chile and Singapore, or with countries such as Australia whose costs are already far above world levels. U.S. textile quotas are due to be abolished in January 2005; given the trade track record of the Bush administration, I think it likely that their abolition will fall victim to the 2004 Presidential electoral cycle. The steel “antidumping” duties of March 2002 are scheduled to be abolished after 3 years; I think it likely that their abolition will be postponed, unless the U.S. economy is roaring ahead by 2005.
The Third World should not look to the EU for salvation. The EU Common Agricultural Policy is now locked in until 2013, while EU development policy has shown time and again that, instead of opening your markets, it is easier to help the Third World by forgiving debt of poorer countries, or by allowing manufactured goods imports from exceptionally poor countries that have neither the capital nor the infrastructure to produce such goods in a cost-effective manner. The EU will have considerable strains in the next decade from absorbing over 100 million workers and consumers from much poorer countries to the East; it is thus most unlikely to participate positively in any great trade-opening initiatives.
As for immigration, the wave of immigration to the U.S. and the EU in the 1980s and 1990s may have improved the lot of individual immigrants in the short term, but in the slow-growth high-unemployment 2000s the benefits of their migration may seem much less obvious to most of them. Meanwhile the societal backlash in the recipient countries is considerable, as evidenced by the substantial votes gained by nationalist parties in various European elections, and it is not going away. Security considerations, too, make free international movement of labor far less attractive than it appeared half a decade ago. Going forward, it is likely that the only immigration that the U.S. and the EU will encourage is that of Third World university graduates with immediately assimilable skills — precisely those people who would most impoverish their home countries if they left.
This future, of a kind of creeping Smoot-Hawley (the infamous 1930 U.S. tariff that shattered international trade and plunged the world into depression) is particularly unattractive if we wish to get out of the current economic difficulties while most of us are still young enough to enjoy it. While the benefits of full free trade are overstated, the costs of increasing protectionism, disrupting trade patterns that already exist, are both huge and incalculable. To estimate their extent, think for a moment of the grim existence endured by the countries of former Austria-Hungary in the 1920s and 1930s, or that endured by the majority of the former Soviet Union today. In both cases the problem was not that the successor countries could not compete internationally, it was that their economies were dependent upon links with partners in countries that were now both foreign and not particularly friendly. It is unsurprising that a majority of Ukrainians would favor a restoration of the Soviet Union; the modest increase in political freedom they have enjoyed since 1991 in no way makes up for their 50 percent drop in living standards.
If free trade is stalled, as, with exceptions that I have suggested are insignificant, it appears to be, then in a recessionary world protectionism will make a comeback, and our living standards will suffer a corresponding decline.
So what should the U.S., acting primarily in its own interests, do about it?
— Don’t waste much energy negotiating further free trade agreements with the EU. They are high cost producers of most goods, and cannot be relied upon to fulfill any reciprocal obligations they may incur (the blocking of genetically modified food crops is evidence of this.) Producer lobbies in the EU will always be able to manipulate their infinitely inventive regulators to stop the U.S. getting any benefit from trade liberalization. The U.S. has no moral obligation to subsidize European welfare systems, or keep over-fatted Stuttgart auto workers in jobs.
— Open U.S. markets for agriculture, textiles and basic manufactured goods, the products in which the Third World is most competitive (and keep open the markets for traded services, an increasingly important sector.) Do not open them indiscriminately, however, but do it on a country by country basis, so that only those countries whose production capabilities are firmly in the hands of the private sector, and whose governments are reasonably honest and committed to free enterprise, get the benefit. Allowing countries such as India, Turkey and Botswana free access to the U.S. market will do far more for their economies than any amount of international aid, which tends to be skimmed off by local bureaucracies.
— Maintain a strong focus, however, on the local government’s commitment to the free market. Chile, which has voted against the free market (albeit narrowly) twice in the last 15 years and Mexico, whose population seems willfully hostile to market mechanisms, were both bad pioneers for a free trade policy. India, South East Asia, Colombia, Botswana, Turkey, Croatia and, in textiles, Pakistan would all be much better pioneers. There is little point in negotiating a free trade agreement with Luis Ignacio (Lula) da Silva’s Brazil or Nestor Kirchner’s Argentina; both countries have shown themselves hostile to U.S. trade interests, and entirely committed to state embezzlement of any additional revenues that free trade might bring their countries.
— Discourage immigration, both of the low-status “refugee” type and the high-status type. Low-status immigration causes huge social problems in the U.S., at a time when jobs will be scarce, and rewards countries such as Mexico and Haiti that pursue bad policies. High status immigration denudes the immigrants’ home countries of their brightest talent, and impoverishes them further. If U.S. markets are opened to Third World countries, their inhabitants will be able to achieve rapidly rising living standards by catering to U.S. markets from their home base, and will in addition thereby raise the living standards of their less fortunate compatriates.
The economic disruption which such a policy would cause inside the U.S. would be limited and temporary — the markets being opened would all be ones in which the U.S. was increasingly uncompetitive in cost, except agriculture, where the extraordinary efficiency of U.S. farming at its best would enable the domestic industry to keep pace (and the budget savings from abolishing agriculture subsidies would be substantial indeed.)
Internationally, the U.S. would by this means pull rapidly ahead of the EU and other protectionist developed countries, and produce a rapidly enriching Third World middle class whose livelihood was dependent on the U.S. market, and on avoiding atavistic electoral choices such as those so common in Latin America.
Most important of all, this is the trade policy that can lead to world economic recovery. Not indiscriminate free trade, but free trade directed where it can do most good.
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(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.)
This article originally appeared on United Press International.