Free Trade Speech

I recently had the pleasure of addressing a meeting in Mankato, Minnesota, hosted by the Heritage Foundation on the subject of trade and its role in Minnesota’s economy. Below are my remarks.

Good morning. Thanks to the Heritage Foundation and their co-sponsors for hosting this event and inviting me to say a few words. Thanks also to you all for coming.

Tori is going to speak to you about the role of trade in Minnesota’s economy. I don’t want to preempt what she is going to say, so I would like to say a few words about the broader debate around trade.

Trade is a positive sum game

Trade is one of the oldest topics in economics. The ancient Greek philosopher Aristotle, who lived in the fourth century B.C., believed that trades had to balance, that people exchanged things of equal value, that that, indeed, was why they were exchanged.

It took until the 19th century for economists to debunk this and show that trade actually takes place because people value things differently. If I hand over $10 to Best Buy for a CD it shows that I value that CD more than the $10. And, on the other side, it shows that Best Buy values the $10 more than the CD. In this instance, each party has managed to trade something they valued less for something they valued more. We are both better off.

Another example; Minnesota produces more soybeans than it needs. Via trade, Minnesotans are able to exchange the surplus soybeans for other things such as electronic goods from China or clothes from Vietnam. It is as though there was some machine just over the Pacific horizon which turns the surplus soybeans we send out there into clothes and washing machines and send these right back to us. Trade works like a magic machine that turns things you want less into things you want more.

Trade is a positive sum game. It makes both parties better off. After all, they wouldn’t do it if it didn’t.

Trade restrictions are a zero sum game

Trade restrictions, on the other hand, are a zero sum game; they make some better off at the expense of others.

The recent steel tariffs, for example, will help U.S. steel producers, in the short run. But what about U.S. steel consumers? Companies such as Smyth in St. Paul, which manufactures cans for craft breweries, will see the cost of their inputs rise. They will either have to cut into their profits, pass the cost on to the consumer, or cut back on production.

The last time the U.S. imposed steel tariffs in 2002, it cost an estimated 200,000 jobs among steel using businesses. What the steel producer gains, the steel consumer loses.

What about losers from trade?

This isn’t to say that trade doesn’t negatively affect anybody. In his 1963 song North Country Blues, Bob Dylan sings about a mining town on Minnesota’s iron range which was put out of business because iron was “much cheaper down in a south American town, where the miners work almost for nothing”. As a kid in Sheffield in England, I saw both the mining and steel industries battered when government support was removed and they were left to face foreign competition.

The answer here is not to close off trade. Remember, what the American coal or steel producer gains by doing so is lost by the American consumer of that coal or steel. Instead, we need policies to retrain these workers and get them back into work.

This needs to be part of a broader rethink of how we approach education and training. Trade is not the only source of what the economist Joseph Schumpeter called “creative destruction”. Innovation also plays a role. And neither is it always blue collar workers who suffer.  

The Harvard Business Review gives this example

“Consider, for example, graphic designers. Until recently, almost all graphic designers designed for print. Then came the Internet and demand grew for web designers. Then came smartphones and demand grew for mobile designers. Designers had to keep up with new technologies and new standards that are still changing rapidly. A few years ago they needed to know Flash; now they need to know HTML5 instead. New specialties emerged such as user-interaction specialists and information architects.”

Given this pace of change, the skills you leave high school with are likely to be obsolete by the time you are halfway through your working life.

If blue and white collar workers are not to be left behind by the changes brought by trade and technological change, learning needs to become a lifelong thing with people in their 30s and 40s looking to master the newest skills.

And policy, at the national and state level, should be designed to help that. The notion that you finish education at the end of High School or on graduation from college needs to go into the dustbin of history.

Trade is often a scapegoat

Trade is also a handy scapegoat, a distraction from some of the real handicaps to our competitiveness.

Until recently, the U.S. government imposed one of the highest corporate tax rates in the developed world. On top of that, our state lawmakers continue to impose the third highest corporate tax rate in the U.S. Then, supporters of such economic self-harm cry foul and blame foreign competition for our problems.

Then there are regulations. What holds copper mining in northern Minnesota back is not competition from the child laborers of the Congo-the fruits of whose labors are in almost every electronic device in this room-but federal and state government regulations which block environmentally sustainable operations which could bring high paying jobs to some of the poorest parts of the state.

The trade deficit is not ‘lost money’

You will often hear people complain about the trade deficit as though it is a bad thing which needs to be fixed. They talk as though it is money being somehow lost.

This is one of the older arguments in economics. In 1776, Adam Smith wrote The Wealth of Nations largely to debunk the doctrines of the Mercantilists. They believed that the purpose of trade was to run a surplus so you could accumulate the gold your trading partners would send to you to cover their deficits. But, as Smith pointed out, money is a means to an end, not an end in itself. The end is consumption of goods and services, not the stockpiling of money balances.

In this respect, the trade deficit is a very good thing for the U.S. In 2017, the US exported $2.3 trillion worth of stuff. In return, it got $2.9 trillion worth of stuff. The balance is the trade deficit. It is the excess of the value of imports over the value of exports. In other words, the U.S. was able to consume about $600 billion more stuff than it sent to other people to consume. So the trade deficit is not a loss of money, it is a gain of consumption.

Indeed, when it is said that the United States has become some sort of ‘piggy bank’ for the rest of the world, the truth is precisely the opposite. The U.S. deficit on trade is financed by its surplus on the capital account. In other words, the rest of the world is lending the United States its savings to finance purchases from the rest of the world by American consumers.

The Chinese population should be angry

Much of the concern around trade at present is centered on China. There is no doubt that China’s government has, in recent years, pursued policies that have given its exporters an advantage.

The Chinese people have been taxed to subsidize Chinese producers. The Chinese central bank has driven the country’s currency down to keep exports cheap. This has also imposed a cost on the Chinese people by lowering the purchasing power of their wages.

Put bluntly, the Chinese, who have a GDP per capita of $16,600, are subsidizing the consumption of Americans, whose GDP per capita is $59,000. You can see why the Chinese public might be angry about this, but you might well be wondering why Americans should be looking this gift horse in the mouth.

Either way, the answer to bad Chinese policy (subsidies and monetary manipulation) is not to impose bad policy in America (tariffs).

The U.S. trade deficit isn’t even a thing

But, more fundamentally, ‘the U.S. trade deficit’ doesn’t really exist. Sure, it shows up in the national accounts, but this is just a statistical aggregate of the countless decisions taken by individuals and businesses within the United States.

And all of us run trade deficits with some and surpluses with others. I, for example, run a hefty trade deficit with Target. They give me goods and all I give them in return are bits of paper with president’s faces on them. In turn, Target runs trade deficits with its suppliers, taking produce from farmers, for example, and handing them dollar bills in return.

By contrast, I ran a heavy trade surplus with my old employer. I provided services to them, researching and writing reports, and they give me cash in return. It was my trade surplus with that employer that allowed me to fund my trade deficit with shops like Target. And my old employer’s trade deficit with me provided them with product to sell to clients with whom they ran a trade surplus.

All the U.S. trade deficit is is an aggregate of all these decisions. If I buy English cheddar from Hy-Vee, Hy-Vee will send the English cheesemonger some cash and receive cheese in return. This will show up in the trade deficit. If I buy Wisconsin cheese, it won’t. The same goes if you buy a foreign car or DVD player. Add all these individual decisions up for the United States and you get either a trade deficit or surplus. Either way, it isn’t clear why you should be worried about it as long as you can pay for it.

About that…

“As long as you can pay for it”; that is an important point. As the U.S. borrows from the rest of the world to fund its excess of consumption from the rest of the world, our indebtedness increases.

This is a problem for us, at some point. But it is also a problem for the people who have loaned us this money. As John Paul Getty is supposed to have put it, “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.”

Clearly these trends cannot continue indefinitely. But neither are they preordained to end in collapse. In a world of floating exchange rates, there are economic mechanisms in place to soften any landing somewhat. Besides, it is in the interest of the lender at least as much as the borrower to avoid that outcome.

The choices we face

There is an old saying that when goods can’t cross borders armies will. That might be rather strong stuff, but in the context of the current debate about immigration, to maintain the high standards of living that low cost production brings us, we have a choice. We can either allow into America the products of low wage workers abroad or we can allow in those low wage workers to make those products here.

If our aim is to build an economy tilted towards investment, increased productivity, and higher high wages, we would be better off pursuing a policy of open trade.

Thank you.

John Phelan is an economist at the Center of the American Experiment.