Free Trade Benefits Vs. Fears Of Foreign Goods

[This piece first appeared here]

Japanese Prime Minister Shinzo Abe spoke before a joint session of the U.S. Congress on April 29, 2015 and offered his “eternal condolences to the souls of all American people that were lost during World War II,” but never directly said that he was sorry for Imperial Japan’s sneak attack on Pearl Harbor on December 7, 1941.

The real purpose for his visit to Washington, D.C. and his address before Congress was to push for Congressional approval of the Trans-Pacific Partnership (TPP) between the U.S., Japan and 10 other nations (Australia, Brunei, Canada, Chile, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam).

Meant to extend and widen trade and related commercial relationships between the participating countries, it is also been presented as a way for the U.S. to maintain his economic and political power in East Asia in the face of the rising influence of China in that part of the world.

TPP is a “Managed Trade” Agreement – Not Free Trade

With negotiations among the twelve governments going on “behind closed doors,” proponents and critics have offered alternative accounts of what is being negotiated and whose benefit will be served in the final agreement.

What should be most clear is that the Trans-Pacific Partnership is not a free trade agreement. Parts of it may, no doubt, lower some trade barriers, thus making easier the production, sale and purchase of a wider variety of imports and exports. However, TPP, like all other trade agreements in the post-World War II era is a managed trade agreement.

That is, governments of the respective participating nations negotiate on the terms, limits and particular conditions under which goods and services will be produced and then bought and sold in each other’s countries. The Japanese government, for instance, is determined to maintain a degree of trade protectionism for the benefit of Japan’s rice producers, who are fearful of open competition from their American rivals.

The U.S. government is under pressure from the American auto industry, for example, to continue limiting greater competition from the Japanese automobile industry. American labor unions want to restrict the importing of goods produced at lower labor costs abroad than U.S. manufactured goods, because American consumers might prefer to buy the lower priced foreign products and thus risking the loss of some of their union members’ jobs.

Free Trade Can be Simple and Unilateral

A real free trade agreement, on the other hand, can be a very simple matter. Congress would pass and the President then sign a short piece of legislation stating something to the affect:

“The United States government herewith eliminates all existing barriers, restrictions, and prohibitions on the free and unrestricted importing and exporting, buying and selling of all goods and services between the United States and any and all nations in the world. The U.S. government declares that all forms of peaceful and non-fraudulent trade, commerce and exchange is the private matter of the individual citizens of the United States and any and all others situated in another country. This law takes affect immediately upon passage.”

Indeed, the United States does not even need the mutual agreement of any other nation to implement free trade. The U.S., with just such a piece of legislation, can establish free trade unilaterally; even if other nations kept some or all of their own trade-restricting barriers in place, America would still be better off.

Let us remember why people trade with one another. Each of us has limited skills, abilities and resources. And there is only so much time in a day to do all the things we might wish to do to produce the goods and services we desire to have.

Division of Labor and Gains from Trade

Furthermore, some of us are better at doing some things than others. The noted Scottish economist, Adam Smith (1723-1790), in fact, began his famous book on The Wealth of Nations (1776) with explaining the benefits from a division of labor. In a small group of tribesmen, one of them sees that a fellow tribe member is better at making a bow and arrows than himself, and in less time than when he employs his own labor to make such a weapon for hunting.

On the other hand, he is quite talented and efficient at tanning animal hides, and offers to trade such a tanned animal hide (that can serve as the covering of a small tent, for instance) in exchange for a set of bow and arrows from the other tribesman who is not very adept at such tanning activities.

Others may offer the bow and arrows “expert” some product that they are relatively good at producing – one who may be good at producing primitive hatchets or knives, another who has superior cooking skills, etc. – in trade for one of his weapons.

Over time, Adam Smith argued, each would find that they could improve the quantities and the qualities of the goods that could be in their possession if instead of trying to self-sufficiently manufacture these things on their own, they were to specialize in what they could do better than their fellow tribesmen and trade their specialized good for the similarly specialized products of their neighbors.

Through a division of labor, productivity is increased far above what individual men in economic isolation can ever hope to attain. It also acts as a stimulus for industry, since now the variety and quality of goods than can be obtained through the exchange of specialized productions work as incentives for each to increase his own output of tradable wares as the means of acquiring what others may have for sale.

And the more extensive the market becomes on which goods can be sold, the greater now the potential benefits from a more intensive development of the division of labor.

Birth of Free Market Economics cartoon

People Trade, Not Governments – For the Benefit of Imports

From these insights, economists like Adam Smith and who came after him demonstrated that trade among nations is mutually beneficial, and in no way harmful to any nation’s “interest.” Why? Because “nations” do not trade, individuals do. And no individual enters into and participates in any exchange unless at the time of the transaction they view themselves being made better off from what they receive in a trade than what they have to give up to get it.

Furthermore, the advantage from all forms of trade, whether between two immediate neighbors, or between people living in two different states such as California and Ohio, or between those residing and working in two different countries separated by thousands of miles, comes not from the ability to “export” but from the opportunity to “import.”

Though I certainly enjoy my job as a professor of economics in an institution of higher learning, the reason I work is to earn a salary that then enables me to buy all the various goods and services that I wish to use and consume. In other words, I “export” my teaching services to others who are willing to pay me for services rendered so I can have the financial wherewithal to “import” all the other goods I wish to buy.

Exports are only the means through which people in one nation can acquire from those in other nations the products that they cannot produce at home, or cannot produce at a cost less than the prices at which others offer them in another country. Trade among nations offers the consumers of each participating country more goods, and different and less expensive goods than if the demanders of those desired commodities were limited to the production possibilities in their own land.

The final demonstration of the mutual benefit from trade among nations came with the development of the theory of comparative advantage by economists inspired by Adam Smith. That trade is beneficial is seen clearly enough if each nation can produce some product that its trading partners cannot produce at all, or if each nation can produce some product at a lower cost that none of their trading partners can match.

Trading Benefits Among the More and the Less Productive

But what was now shown was that trade was mutually beneficial even if one of these nations was absolutely more cost-efficient in producing every product in comparison to its potential trading partners.

Suppose I hire a housekeeper to clean my cloths and cook by food even if I can do both of these tasks better and in less time than they can, but if by paying them to do so, they free my time to do things in the market place that generates a higher income that may more than compensates for what I pay them.

For instance, suppose that I could do these two activities for myself in four hours of time each day, while the professional housekeeper will take six hours to complete these same tasks and for which they will charge me $10 an hour for a total cost of $60.

But suppose that by freeing me from four hours of household chores, I can produce and sell a product or offer some labor service, myself, which would earn me the equivalent of an income of $25 per hour, or a total of $100. By hiring the housekeeper, I net an extra $40 ($100 earned minus $60 paid to the housekeeper), that otherwise would not be available to me to buy things I might desire.

If I value more highly what that extra $40 of net income will enable to be buy more than staying home and making a tastier meal for myself and folding my cleaned clothes a little neater, then I will hire the less efficient housekeeper to free up my time so I can do those things for which the market places a higher value than the housekeeper’s abilities.

Specializing at What You are Relatively Most Productive

The same logic explains the trade among nations.

Suppose that the people in the nation of Superioristan can produce a yard of cloth in four hours and can harvest a bushel of wheat in one hour, while the people in the nation of Inferioristan take, respectively, twelve and two hours to perform the same two tasks.

Clearly Superioristan is a lower-cost producer than Inferioristan in both cloth and wheat production. Superioristan is three times more productive at cloth manufacturing (four hours instead of twelve) and twice as productive at wheat harvesting (one hour instead of two).

But it is equally as clear that Superioristan is comparatively more cost-efficient in cloth manufacturing. That is, if the people of Superioristan forego the manufacture of one yard of cloth (four hours of work) they can harvest four bushels of wheat (each harvested bushel taking one hour) with the time that has been freed up. But when the people of Inferioristan forego the manufacture of a yard of cloth (twelve hours of work) they can harvest six bushels of wheat (each harvested bushel taking two hours).

If Superioristan and Inferioristan were to trade cloth for wheat at a price ratio of, say, one yard of cloth for five bushels of wheat, the people of both nations would be better off, with Superioristan specializing in cloth manufacturing and Inferioristan in wheat harvesting.

Superioristan would now receive five bushels of wheat for a yard of cloth in trade, rather than the four bushels if it harvested at home all the wheat consumed. And Inferioristan would receive a yard of cloth for only giving up in trade five bushels of wheat, rather than the six bushels if it manufactured at home all the cloth needed and used.

The people of every nation can find a place at the table of global trade, even if they are less productive and efficient than many or all their trading partners, by producing something for which they have a comparative advantage that enables some one or more of their trading partners to specialize in those activities for which they are most productive.

Linus's Protectionist Blanket Cartoon

The Errors in Various Trade Fallacies

Let us briefly review some of the objections sometimes raised against freedom of trade.

1. Unfair Trading Practices. Many other nations directly or indirectly subsidize the exports of some of their producers to the United States at prices below their actual costs of production. To the extent that this is actually done, this means that American consumers are given a bargain.

 Suppose that a product that would, otherwise have cost $10 to buy now can be purchased from the subsidized foreign supplier for $6. Americans now have the desired commodity for $6 instead of $10, plus have the $4 difference left in their pocket to spend on something they otherwise would not have been able to afford. American standards of living are increased due to the foreign export subsidy.

Who should view themselves as having been taken advantage of? Surely, it should be the citizens in the foreign exporting nation, who have been forced to pay higher taxes to cover the cost of the subsidy given to a privileged producer in their own country. They have been taxed so American consumers may purchase something below market-based costs to the benefit of a special interest in their own land.

2. Foreign-Made Goods Cause Jobs Losses at Home. Whether subsidized or not, the charge is often made that foreign imports result in lost business and jobs for Americans. It is true that American firms that cannot successfully compete against their foreign competitors may lose business and may even in some cases go out of business.

 But foreign exporters do not give us their goods for free. They desire to earn revenues and income for the same reason that we do, to have the financial wherewithal to buy other goods we desire to buy as income-earning consumers.

Thus, the dollars earned by foreign exporters are spent in one way or another on American goods and services that these foreign dollar-earners find attractive and desirable to buy. Thus, part of the business and jobs “lost” due to foreign competition are made up in the American the export trades as the means for supplying the goods that serve as the ultimate payment for the goods imported.

At the same time, the dollars saved on purchasing less expensive foreign imports, leaves dollars in the pockets of American consumers that enables them to demand other goods here at home that they previously could not afford. This, in turn, creates part of the alternative business and employment that may have been lost as a result of those foreign imports.

What changes is the composition of the types of products produced in America and the types and location of some of the jobs performed by American workers. But as long as markets in America are relatively competitive and adaptive to change, there need be no net loss of jobs. There is always work to be done as long as people have unsatisfied wants. And in this way, there is work for all who are willing to work at market-determined prices and wages, and with higher standards of living due to more and better goods at lower costs.

3. Foreign Trade Barriers to American Goods. Suppose America unilaterally, lowers its trade barriers but the governments of other countries now selling more exports to the Unite States keep their trade barriers in place, not allowing their own citizens to import more American goods?

 Then the dollars earned by the foreign exporters either will be sold on the foreign exchange market to those interested and willing to buy American-made goods, or dollars earned from selling goods in the U.S. will remain in America and used for either direct or indirect investments in the American economy. If the latter, this increases the pool of savings and investable resources to finance capital formation in the United States, therefore assisting in enhancing America’s future productive capabilities in the global market.

Suppose that the dollars earned by the foreign exporters were to be “hoarded” in that foreign nation, neither spent on American goods nor saved and invested in the American economy. To the extent this was to be done, the foreign exporters and their governments are giving Americans an implicit “interest-free loan.”

That is, they have given us their goods and not demanded any goods as payment for them. In other words, it is as if they have given us their goods “on credit” and indefinitely delayed when they insist upon being paid back in the form of the goods they could demand from us by offering to trade their earned dollars for actual goods and services on the American market.

For as long as, hypothetically, those dollars were to be hoarded in those foreign countries the resources and labor that would have had to be, otherwise, devoted to manufacture the exports to pay from what we had imported are freed up to be used to make other goods that Americans would like to have.

4. Trade Makes Our Rivals Stronger, and Can Lead to Conflict and Possible War. The greater and more intensive our trading relationships with other nations, the more interdependent we become with them. That very interdependency can serve to reduce the likelihood of war by increasing the its cost.

 I sometimes explain to my students, imagine it is the year 2030. China has grown in economic and military power, and the Chinese and American governments have gotten into a political conflict with both sides rattling their sabers and threatening war.

In Beijing, a young man knocks on the door of one of the top Chinese generals and enters his office. The young man says: “Pop, what are you doing? Are you going to ‘nuke’ San Francisco? Don’t you know I’m heavily invested in Silicon Valley, and your daughter-in-law and grandchildren are vacationing at our new condo near Fisherman’s Wharf looking out over the Golden Gate Bridge?”

Countries have and no doubt will continue to go to war for various reasons. And trade does not guarantee that it does not happen. But strong and deeply interconnected trade relations raise the costs of conflict. You rarely improve your own economic wellbeing by killing your customers and destroying your own resource supplies and capital investments.

Long ago, the famous Scottish philosopher, historian and economist, David Hume (1711-1776) explained the benefits from international trade and division of labor. In a well-known essay of his, “Of the Jealousy of Trade” (1758), Hume pointed that international trade offers opportunities to discover and learn about new technologies, new methods of production and new varieties of products that otherwise might never be known and taken advantage of if nations attempted to economically close themselves off from commercial interaction with their neighbors.

He argued that if a domestic industry found it difficult to meet the competition of their foreign rivals, “they ought to blame their own idleness, or bad government, not the industry of their neighbor.”

The fear of lost business and jobs from foreign trade, Hume said, was misplaced. “If the spirit of industry be preserved, [production] may easily be diverted from one branch to another” if markets are kept open, competitive and not hampered by the heavy hand of government regulation, control and burdensome taxes.

All who participate gain from international trade, and all are made poorer to the extent that governments interfere or prohibit the freedom of trade among the peoples of the world.

To slightly paraphrase from the closing paragraph of this essay of Hume’s, “I shall therefore venture to acknowledge that, not only as a man (benevolently wishing the best for all of mankind), but as an American citizen (desiring the prosperity of my own country), I pray for the flourishing commerce of Germany, Japan, Great Britain, France, and even China, Russia and Iran themselves. I am certain, that America, and all those nations, would flourish more, did their governments and political leaders adopt such enlarged and benevolent free trade sentiments towards each other.”