The forgotten secrets of free trade justify Trump’s tariffs

Summary:  Trump’s tariffs threatens a trade war that might destroy the global trading regime that has helped the world become so prosperous. His opponents cite the famous conclusions of David Ricardo about free trade – while forgetting what he said.

Contents

1. The wonders of free trade.
2. The ugly math of free trade.
3. Slowly the news spreads.
4. Problem recognition is the first step.
5. Let’s share the pain of free trade.
6. Conclusions.
7. For more information.

(1)  The wonders of free trade

The free flow of capital, jobs, and trade was a pillar of the post-WWII geopolitical regime. Economists and the foreign policy establishment assure us that this globalization is an unqualified good thing – a “win-win” for all parties. That is, of course, absurd. Globalization in its current form has clearly become problematic for America. It has weakened us in important ways during the past 3 decades. Especially since the decision in 2001 to admit China to the World Trade Organization.

Fast forward to the present. For four years we have run a deficit in the trade of goods and services of 3% of GDP. Starting in October the deficit began to grow alarmingly.

“For the first two months of the year, the deficit was $114.3 billion, 23% wider than a year earlier. Imports were up $44 billion, or 9.1%, for the first two months of the year from a year earlier. Exports grew 5.9%, or $22 billion, in the first two months of the year from a year earlier.” {From WSJ.}

Political support for free trade has eroded.  Now Trump shakes the global trade system, adopting ineffective measures that might start a trade war that with large and painful consequences (see Paul Krugman’s posts in the For More Info section). It is a foolish response to a real problem. How did we get into this mess?

(2)  The ugly math of free trade

David Ricardo is famous for explaining the benefits of free trade in (The Principles of Political Economy and Taxation, chapter 7, 1817). He said that both sides benefited – if certain conditions were met. We have built our global economic system on his insights but forgotten his conditions.

Roy J. Ruffin reminds us of those forgotten aspects of free trade in “David Ricardo’s Discovery of Comparative Advantage“, in History of Political Economy (Winter 2002). It should force us to consider what Ricardo would tell us if he was alive today. Red emphasis added.

“These observations are Ricardo’s ‘home runs.’ Ricardo emphasized the “four magic numbers” as well as stating that because Portugal has an absolute advantage in the production of both cloth and wine:

‘it would undoubtedly be advantageous to the capitalists of England, and to the consumers of both countries, that under such circumstances, the wine and the cloth should both be made in Portugal, and therefore that the capital and labour of England employed in making cloth, should be removed to Portugal for that purpose.’ (Ricardo, I, p. 136)

“Accordingly, Ricardo realized it was necessary to suppose factor immobility between countries. Indeed, of the 973 words Ricardo devoted to explaining the law of comparative advantage, 485 emphasized the importance of factor immobility!“

Here’s a link to Ricardo’s discussion of mobile and immobile factors of production. Knowledge, capital, and labor were immobile in 1817. Today modern communications and cheap transportation mean that land is the only immobile factor — and land matters not at all.

(3) Slowly the news spreads

Today, sophisticated manufacturing can be done almost anywhere. Our knowledge and capital are quickly deployed to competitors. This exposes a large fraction of our workforce to global wage competition. Even so, our exposure to foreign competition was manageable so long as it was limited to traditional tradable goods.

Now services are becoming global businesses. Software engineering, radiography, operation of call centers – another tranche of jobs, low and high paying jobs — are going away. The core of America’s middle class has become vulnerable.

This has been known for years. Slowly awareness of this spreads among the US people, and the political support for free trade weakens. Will Americans passively watch their “class interests” (a Marxist education is becoming more useful these days) erode away in order to maintain record high corporate profit levels?

(4)  Problem recognition is always the first step

(a)  “Is Off-shoring Really Just Good Old Free Trade?” by Herman Daly and James Socas, presented to a Senate Democratic Policy Committee Hearing, 5 March 2004. Daly is a Professor at U Maryland, was a Senior Economist at the World Bank. Summary:

“Many academic economists argue that off-shoring is simply the next chapter in ‘free trade’ theory – a ‘good thing.’ However, some politicians of both parties are beginning to question whether off-shoring represents a fundamental break from the past. To them it appears that off-shoring is not free trade, as most think of it, but the systematic substitution in the production process of higher cost U.S. workers by lower priced foreign workers, due to an increasingly integrated global economy. The result is rising corporate profits, but falling U.S. jobs, stagnating wages, and enormous pressure on the country’s middle class.

“The authors contend that what is happening in today’s globally integrated economy is not the classical operation of ‘free trade,’ and, they point out, that argument can be found in the original writings on which free trade theory is based.”

(b)  “Offshoring: The Next Industrial Revolution?” by Alan S. Blinder in Foreign Affairs, March/April 2006. Blinder is no anti-globalization nut, right-wing reactionary, or even just another economist. He is Professor of Economics at Princeton, member of the White House Council of Economic Advisers (1993-1994), Vice Chairman of the Board of Governors of the Federal Reserve (1994-96). Excerpt:

“Although there are no reliable national data, fragmentary studies indicate that well under a million service-sector jobs in the United States have been lost to offshoring to date. A million seems impressive, but in the gigantic and rapidly churning U.S. labor market, a million jobs is less than two weeks’ worth of normal gross job losses.) However, constant improvements in technology and global communications virtually guarantee that the future will bring much more offshoring of “impersonal services.’ That is, services that can be delivered electronically over long distances with little or no degradation in quality.

“That said, we should not view the coming wave of offshoring as an impending catastrophe. Nor should we try to stop it. The normal gains from trade mean that the world as a whole cannot lose from increases in productivity, and the United States and other industrial countries have not only weathered but also benefited from comparable changes in the past. But in order to do so again, the governments and societies of the developed world must face up to the massive, complex, and multifaceted challenges that offshoring will bring. National data systems, trade policies, educational systems, social welfare programs, and politics all must adapt to new realities.

“Unfortunately, none of this is happening now.”

(c)  Testimony of Alan S. Blinder to the Joint Economic Committee: “Will the Middle Class Hold? Two Problems of American Labor“, 31 January 2007

“…the dividing line between jobs that are deliverable electronically (and thus are threatened by offshoring) and those that are not does not correspond to traditional distinctions between high-end and low-end work. …

“First, we need to repair and extend the social safety net for displaced workers. This includes unemployment insurance, trade adjustment assistance, job retraining, the minimum wage, the EITC, universal health insurance, and pension portability – plus other, newer ideas like wage loss insurance. …

“Second, we must take steps to ensure that our labor force and our businesses supply and demand the types of skills and jobs that are going to remain in America rather than move offshore. Among other things, that may require substantial changes in our educational system-all the way from kindergarten through college.”

Blinder gives the standard remedies: welfare, retraining, and more education.

1. More welfare is likely both insufficient unsustainable as “outsourcing” grows from the manufacturing sector to the larger service sector, and effects higher-wage jobs.
2. Re-training just pushes more workers into the ever-smaller boat of jobs not exposed to foreign competition.
3. Calling for more education is nuts. Consider the plight of middle-aged workers with advanced professional degrees. Do they return to school to get a 2nd masters, or a PhD competing for the tiny pool of jobs for which these are required?

(d)  Paul Krugman in “A Protectionist Moment?“, March 2016,

“But it’s also true that much of the elite defense of globalization is basically dishonest: false claims of inevitability, scare tactics (protectionism causes depressions!), vastly exaggerated claims for the benefits of trade liberalization and the costs of protection, hand-waving away the large distributional effects that are what standard models actually predict. …

“Furthermore, as Mark Kleiman sagely observes, the conventional case for trade liberalization relies on the assertion that the government could redistribute income to ensure that everyone wins — but we now have an ideology utterly opposed to such redistribution in full control of one party, and with blocking power against anything but a minor move in that direction by the other.

“So the elite case for ever-freer trade is largely a scam, which voters probably sense even if they don’t know exactly what form it’s taking.”

Yet our ruling elites remain unmoved by the growing evidence. Now pressure has grown too great, and rogue President Trump threatens to capsize the system.

(5)   Another perspective: let’s share the pain of free trade

“The Minimum Wage and Doctors’ Pay“, Dean Baker (economist and co-director of the Center for Economic and Policy Research) on “Beat the Press”, 24 June 2006. Excerpt (emphasis added)…

“To me, the main economic story of the last 3 decades has been that those in high paying professions (e.g. doctors, lawyers, dentists, accountants, economists etc.) have managed to drive up their wages by sustaining and increasing barriers against competition (both foreign and domestic), while less-skilled workers, like autoworkers, textile workers, dishwashers, and custodians have been deliberately placed in direct competition with low-paid workers in the developing world.

“The wages in these latter categories have generally been flat or declined over this period, while workers in most of the high-paid professions have seen substantial pay increases (e.g. the OECD reports that the real wages of doctors in the United States increased by 55% from 1964-1995 [sorry, it’s not free data, so I can’t link to it]). If this pattern is to be reversed, then the wage increases for workers at the middle and bottom will have to come at least partly at the expense of the real wages of high-end workers, just as the wage gains of high-end workers have come partly at the expense of those at the middle and bottom over the last three decades.

“This is all accounting; one can debate the merits of specific policies to reverse the upward redistribution of income, but there really is not much room to debate the accounting. My favored policy is free trade in professional services, so that doctors, lawyers, accountants and economists can enjoy international competition in the same way as autoworkers, textile workers and dishwashers. (See chapter 1 of The Conservative Nanny State.)”

(6) Conclusions

“Do I disapprove of Trump’s trade methods? I don’t see any method.”
— Tweet by Paul Krugman.

Conditions in the US resemble those before many severe public policy mistakes. The only missing ingredient is a recession to supercharge the pressure to take large-scale but ill-considered measures. The situation results from our elites misusing economic theory to support policies they find profitable, ignoring the consequences for many citizens, and so allowing support for a key part of the international economic regime to wash away.

Much as they have done with the rule and consensus based geopolitical system the United States built after WWII. I suspect that neither of these things will end well for us.

(7)  For more information

Reports about free trade and globalization.

1. “Fear of Offshoring” by Alan Blinder in the WSJ, 2005 (31 pages).
2. Pain From Free Trade Spurs Second Thoughts Mr. Blinder’s Shift Spotlights Warnings Of Deeper Downside in the WSJ, 2007.
3. “Globalization, Worker Insecurity, and Policy Approaches” by the Congressional Research Service, 2008 (18 pages).
4. “Economists’ Dubious Relationship with Trade Policy” by Yves Smith at Naked Capitalism, April 2018 – “Comparative Advantage is a System that Works for the Wealthy.”
5. Paul Krugman about our trade with China: “The Art of the Flail.“
6. Paul Krugman about the costs to America of a trade war: “Trade Wars, Stranded Assets, and the Stock Market.“

Ideas! For shopping ideas, see my recommended books and films at Amazon.

If you liked this post, like us on Facebook and follow us on Twitter. See all posts about globalization and free trade, and especially these…

1. Globalization and free trade: wonders of a past era, now enemies of America?
2. Cheap Imports Backfire on America’s Retailers & What’s Left of Our Economy.
3. A Harvard Professor explains the populist revolt against immigration & globalization.
4. Before Trump, top economist Joseph Stiglitz warned about globalization.
5. Stratfor: Trump risks a trade war with China that cannot be won.
6. A powerful defense of free trade by Ed Dolan, before Trump attacks it.
7. Stratfor: will Trump end free trade in food, & wreck US farmers?
8. The forgotten secrets of free trade justify Trump’s tariffs.