The fiscal benefits of free trade

Western governments have an overriding problem, and that is they have reached or exceeded the bounds of taxation, at a time when legally mandated welfare costs are accelerating. Treasury departments in all the welfare nations are acutely aware of this problem, to which there’s no apparent solution. The economic recovery, so consistently forecast since the great financial crisis, has hardly materialised and has added to the problem.

There is, if treasury economists could only understand it, a solution in free trade.

One of the UK’s leading economists and Brexiteers, Patrick Minfordi, produced an interesting paper, which brought up this subject. It got little coverage in the press, and even that was extremely negative. Trading on the Future was the only economic modelling exercise that showed significant benefits for Britain from free trade.ii

This is the headline from the Independent (19 April): “Only economic study showing benefits of Brexit debunked as ‘doubly misleading’.” The establishment, which is not attuned to free trade, strongly disagreed and presumably felt bound to protect its position.

The problem with Professor Minford’s paper is that he was compelled, by standard macroeconomic practice, to model the economy under different scenarios. It then becomes a debate about whose model is right, as opposed to which economic theory is right. We all know the old saw about computer models and garbage in and garbage out, so defending statistical assumptions becomes little more than a slanging match. And if all the models but one agree, who is going to take the one seriously?

This diverts attention from the excellent points that Professor Minford makes separately from his model, which broadly concur with common sense. Common sense, in this context is properly reasoned economic theory in terms capable of being understood by one’s fellow man. That it has long been abandoned by the macroeconomic establishment is a theme which will be familiar to my readers.

Professor Minford argues that free trade lowers prices for the benefit of the consumer. If tariffs are removed, it is a statement of the obvious. After all, a tariff is a tax on consumption, and if the tax is not imposed, prices will be lower. Furthermore, the competition triggered by a national market being opened to more foreign manufacturers is likely to drive prices down even more. The consumer benefits from free trade, and with the same wages, he can buy more goods and services.

The boost to the economy from lower consumer prices is an excellent result, with clear fiscal benefits. But hold on; are not higher prices, the objective of monetary policy, the only thing that gets the consumer buying? Professor Minford, to ordinary intelligent men, makes sense. But to the establishment economists in their ivory towers this is no less than insurrection against their cherished assumptions.

The ridiculousness of the establishment view on prices is easily illustrated. Imagine your local supermarket offers its customers tins of baked beans at half price. Presumably, it expects to increase its sales of tins of baked beans sufficiently to increase its profits. And indeed, they fly off the shelves. This, according to the belief-driven theories of establishment economists, should not happen. If the supermarket wishes to stimulate buying of tins of baked beans, it should raise prices to persuade customers that they should buy before the price rises again. It truly is a subject for a latter-day Lewis Carroll.

With this sort of thinking prevalent in the corridors of power, it should be obvious why Professor Minford’s arguments must be taken seriously. We must get away from opinions based on garbage-fed economic models. Furthermore, the cabinet ministers directly involved in Brexit and trade negotiations appear to be more instinctively inclined than their Treasury colleagues to think along Professor Minford’s lines. There is a winnable case to be made.

The thesis is very simple, and has good historical precedent. In the mid-nineteenth century, the British government repealed the Corn Laws and then disposed of all trade tariffs, without waiting for other countries to reduce theirs. Lower food prices meant that instead of just working to feed himself, the average worker had some money left over in his wages to buy other things. Consequently, the standard of living for the ordinary person improved, and employment in manufacturing increased with it.

This is the basic argument behind Professor Minford’s paper. You don’t need a computer model to understand it. But for the government, the most important advantage is that repeating the Corn Law experiment in today’s modern economy will produce higher tax revenues on the back of the economic benefits. Professor Minford estimates this will generate an increase of 7.3% of tax revenue for the British treasury, which in another paper he put at £47.5bn, including the £8bn annual payments to the EU that will cease. This solves the UK’s budget deficit, which in the last fiscal year was slightly less than that at £46.6bn, but expected to be somewhat more in the current fiscal year.

You would think the Treasury would welcome free trade on this basis, but it appears the Chancellor’s advisors are still stuck with the economic establishment’s groupthink, the views that incorrectly modelled an economic disaster post-Brexit. However, that could change, particularly given the carrot of increased tax revenue. If I was an advisor to HM Treasury that is the aspect of Brexit I would promote.

If, and when, the Treasury are fully on board then all Brexit controversy at government level should end. And as Professor Minford argues, there is little Britain can do about the EU’s future trade policy with the UK, making prolonged and detailed negotiations somewhat pointless. If they want to hang themselves, that is up to them.

Nowhere is this more obvious than the debate about border controls between Northern Ireland and the Republic. A free trade policy will mean no border controls on the British side. Only yesterday, the British government confirmed that this is their intention. If the Republic of Ireland decides to put in customs posts and split Ireland into two, going against their long-standing desire to unite the North and South, so be it.

Trumpian blunders

The point about government revenue being maximised by free trade also has important implications for America, where President Trump has strong leanings towards protectionism. This runs counter to the benefits of free trade maximising tax revenue. Yet this year, once again, debt ceilings are having to be raised, and escalating future welfare liabilities are rapidly becoming today’s problem. Given what we know by applying our common sense, that free trade increases economic activity, and therefore maximises tax revenue on the back of it, trade protectionism is not the way to achieve President Trump’s stated goal of making America great again.

From the fiscal point of view, it should be clear that restrictive trade practices amount to shooting oneself in the foot. Sentiment and catchy slogans are one thing, government mercantilism another. America has been here before, back in the 1930s, when the Smoot-Hawley Tariff Act, driven by the Trumpian sentiment at that time, made a bad situation considerably worse.

Its introduction meant that manufacturing costs increased due to tariffs being raised on over 20,000 imported goods, many of them vital to production. At the same time, consumer prices were collapsing in the crisis phase of the credit cycle. By widening the gap between production costs and consumer prices, Smoot-Hawley made the depression both deeper and longer than it would otherwise be.

Commodity prices at that time were measured in gold, through the dollar-gold exchange standard at $20.67 per ounce. If commodity prices collapse again, it will be reflected in gold’s rising purchasing power, not the dollar’s, which will be in free-fall. The dollar will plummet because we can be certain the Fed will redouble its efforts to expand the quantity of dollar money, because that is its mandate from the government.

Globally, free trade is taking over

The days when trade protectionism was enforced on everyone else by America, or the EU for that matter, are over. WTO rules, which are the base-case for trade not regulated by agreements, are not substantially different from free trade, an average tariff burden of four or five percent on manufactured goods. This is much less that currency volatility. These are the conditions that have allowed emerging markets to prosper, not only through trade with the advanced economies, but increasingly between each other. Consequently, they have become far more important relative to the developed nations in the global context. North America, the EU and Japan are currently about 54% of the global economy’s GDP, having been 72% in 2000. America itself has declined from 31% to less than 25% of world GDP over the same time-frame.

The election of President Trump, who is regarded by foreign nations as unsupportive of international agreements, such as NATO climate change and the rest, or just plain unpredictable, has loosened the ties between America and her long-standing allies. He tells Germany that selling cars in America is unfair, and expects Germany to implement American trade sanctions against Russia, a lucrative and growing market for her. There are credible reports that Germany is unofficially discussing trade matters with Russia, and we should not be surprised.

Germany, now that Britain is leaving, will dominate the EU. She is likely to use free trade to her advantage, bound by but no longer relying on Brussels to negotiate trade agreements. Japan’s corporations have most of their factories spread throughout South-East Asia, with an emphasis on China. Britain is almost certain to follow the Asian story post-Brexit, with the additional bonus of natural markets in the Commonwealth.

There is little doubt therefore that Japan, the EU and Britain will refocus their trade from an isolationist USA towards a dynamic Asia and the rest of the world. In the event President Trump introduces a latter-day Smoot-Hawley, the effect on the rest of the world would be relatively minor, compared with the experience of the 1930s. Most harmed will be the American consumer, and the US Treasury.

Alarmingly, there are powerful elements in the Trump administration determined to use trade as a weapon in the fight for global hegemon. Only yesterday (16 August) Steve Bannon (the White House chief strategist) gave an interview with The American Prospect which quoted him as saying “To me, the economic war with China is everything. And we have to be maniacally focused on that.” His stall on trade could not be laid out more clearly.

It’s not only America that sacrifices free trade, but other advanced nations do as well, for differing reasons. The resistance to free trade is essentially political. Big business, which tends to be monopolistic, lobbies for protectionism, disliking competition. After all, if you have a factory making simple widgets in France, paying all the social taxes, and stuck with restrictive work practices, foreign competition without those cost burdens is likely to put you out of business. It is not difficult to get politicians to increase trade tariffs and barriers to protect jobs.

Put another way, the profitable redeployment of capital has become increasingly inefficient in all the welfare states. If widgets are no longer being bought, the factory in France will close, unless government subsidises unprofitable production, which it always does. In Asia, if widgets are no longer wanted in the markets, workers are retrained and redeployed to make something else. The release of labour resources to more productive employment is welcomed, while in countries like France it is strongly resisted. China, and the other countries in South-East Asia, have a far more positive attitude to business and trade, and it shows.

Free trade, or what passes for it under WTO rules, is now driving the global economy, coupled with improvements in communications, technology and automation. The losers are those who will not or cannot adapt to this reality. The EU will be forced to adapt, because Germany will set the pace. No matter the European countries that don’t keep up will go bankrupt – Germany is paying the bills anyway.

Meanwhile, America, pursuing her political and geopolitical agendas is cutting herself off from this future. The decline in her share of world trade will continue, and even accelerate as President Trump calls forth the ghosts of Senator Smoot and Representative Hawley.

i Professor Minford currently holds the chair of Applied Economics at Cardiff University. He also chairs Economists for Free Trade.

ii Published by Politeia, April 2017. See www.politeia.co.uk/category/publications/brexit