1. What Is "Compensated Free Trade"? The next day after the Britain's Brexit vote, President Obama said that "... vote speaks to the ongoing changes and challenges raised by globalization." Brexit is ending globalization in its existing unbalanced form, which has created many difficulties, including colossal trade deficits, for the USA. So let us seize the opportune moment. To eliminate or mitigate these difficulties, I have proposed "Compensated Free Trade".
"Compensated Free Trade" (CFT) is a proposed unique, fundamentally novel policy of organizing international trade. Every year, a country that has a deficit trade balance imposes limiting constraints on individual deficits, derived from trade with each trading partner. The sum of these constraints should equal at most the desired overall annual trade deficit of the country. Smaller "punishing limits" may be imposed on misbehaving partners, while the limits for friendly and well-behaving partners may be raised.
A partner may exceed its trade surplus limit if its government pays the government of the deficit country for the excess deficit. Both the number and zeal of customs inspectors dedicated to accepting goods imported from a partner would depend directly on that partner's relevant behavior. For instance, if a partner does not pony up, all excessive imports from it could have to pass through a single customs inspector. France did that in the last century to control the import of Japanese cars.
If the market of a country is sufficiently attractive for its trading partners, which condition is currently satisfied at least for the USA, this country can unilaterally impose CFT on them. That distinguishes CFT from all other proposals of "managed trade" policies. No more utopian wishful thinking about productive international cooperation; no more endless haggling with zero or minimal results.
2. Potential CFT Benefits. CFT creates a versatile geopolitical and economic tool of enormous power, which would kill a quite surprising number of plump birds with just one stone. (Contrary to selfish wishes of economists, geopolitics always played extremely important role in international trade, and vice versa.) If imposed by the USA, CFT would:
• Sharply raise the geopolitical status of the USA and its allies, increasing their capability to contain and confront the adversaries of the democratic world order.
• Handle potential economic disadvantages of Trans-Pacific Partnership, thus removing obstacles to approval and implementation of this agreement, crucially important from the geopolitical point of view.
• Help in "persuading" other countries to participate in activities, necessary to save the ecology of our planet.
• Be fully consistent with both spirit and letter of GATT and thus be protected from being banned by the WTO.
• Completely restore the presently dysfunctional global market, bridling globalization by balancing the needs and requirements of countries with trade surpluses and deficits.
• Improve each annual trade balance of the USA by hundreds of billions.
• Help to restore its social balance and industrial might.
• Eliminate the need in 45% import tariffs, proposed by Mr. Trump, and thus reduce the threat of inflation.
• Prevent trade wars and recriminations.
• Prevent by-passing the deficit limits by redirecting the exports to the USA through other countries.
• Provide annual "risk management" corrections of "eternal" trade agreement with the trading partners, changing their limits in accordance with the then existing economic conditions and with the behavior of these partners, and thus avoiding the need to re-negotiate these agreements.
• Confront, in one wholesale stroke for each partner, government subsidies, price and currency manipulations, and other dirty tricks of international economics.
• Create a new type of capitalism, "balanced capitalism."
• Safeguard the country from evils of both free trade and protectionism, being a compromise between them and achieving the goals of the latter without applying its both costly and forbidden tools.
• Be fully pragmatic, realistic, and non-ideological.
• "Shift the paradigm" of the theory of international economics.
• Eradicate some serious misuses of the general theory of economics.
Whenever these short definitions need additional explanation, it is provided below. Some negatives of free trade and globalization are outlined. A brief history of CFT is also included.
3. Trouble with Trade Deficits. It is clear that the trade deficit countries need financial help. Indeed, what would happen when such a country runs out of its wealth? According to the Herbert Stein's Law, "If something cannot go forever, it stops." How do you stop a country?
In 1991, the Soviet Union disintegrated. That was triggered by trade deficits. Before lowering of the oil prices in the 1980s, the foreign trade inflows and outflows of the USSR were approximately equal. The drop of oil prices halved the inflows, so that the country started borrowing.
In 2006, Yegor Gaydar, the deputy prime minister of Russia in the beginning of the 1990s, published in Moscow a book Death of an Empire (in Russian). He said that the Soviet Union disintegrated primarily because it had to borrow from its enemies. Caveat America!
But even before disintegration, consequences of long-term deficit trade impose enormous stress on the country - both its society and its geopolitical standing. The benefits of globalization are promised in a far-away, nebulous future. Its negative effects are felt immediately. By 2015, according to P. Buchanan, "Since Bill Clinton took office, the U.S. trade deficits have totaled 11.2 trillion." And "Political Backlash Grows in Washington to Chinese Takeovers," including acquisitions of military and technical importance, reports New York Times. A Chinese billionaire declared recently: "We have bought their buildings, we have bought their companies and now we are going to buy their art." I am not speaking about jobs here yet.
4. Avoiding "Tragedy of the Commons." We should not forget that the overall trade balance of a country is a national "common good," and negligence to control it is an extremely serious violation of the economic theory; it undermines its very foundation. With no exceptions, it leads to "tragedy of the commons." If absent, that control should be restored. A fee or a tax or a constraint should be imposed on its free use.
Why did not the economists treat that balance as a "common good"? Two economic theories underlie international trade: "the law of comparative advantage" of Ricardo and its modern expansion by HOS (Heckschter-Ohlin-Samuelson) model. In both theories, product prices are instantly adjusted in such way that trade becomes no more than barter and balances of all countries always equal zero. Money plays just an auxiliary role of bookkeeping. (Other abstract assumptions of these theories are outlined later.)
As described this year by Profs. Cohen and DeLong in "Concrete Economics," until the 1980s "American government did not accept ideological handcuffs. ... [T]he US government even deliberately devalued the dollar in the interests of national prosperity. ... America used all the tools..." of self-protection. Therefore deficits, if any, were small and did not deserve attention. "But beginning in the 1980s, America has been getting its economic policy wrong." Mesmerized by dreamed-up fantastic advantages of post-industrial society, America cut its share of manufacturing in the economy from 21 percent to 14 percent - by one third! Its appetite for manufactured goods did not, however, slacken.
5. Controlling the Trade Deficits by CFT. Governments and businesses of almost every country did not care a hoot about abstract utopian theories and were happy to fill the stupid USA goods gap. And, contrary to a world of fantasy, positive money balance was one of the main goals of trade. Especially successful in implementing export-oriented policies were East Asia nations, but such countries as Germany were not far behind. (The total 2015 trade-in-goods surplus of China equals $604B. The total 2015 trade-in-goods deficit of the USA has been $759 billion; the largest contributors have been China, Germany, Japan, and Mexico, with bilateral surpluses of $366, $74, $69, and $58 billions, respectively. It is more than the Pentagon budget, almost an $830B stimulus, and nobody objects. And China has 48 percent of that surplus! In services, the USA usually has overall annual surpluses of $200+ billions, that decreased the overall USA trade deficit.)
Some pragmatic economists have lately been opposed to unbridled globalization and alarmed by its financial outcomes. For example, in the cited above book Cohen and DeLong have paid a lot of attention to the USA trade deficits. But, as far as I know, nobody ever treated the overall deficits as a common good of a nation state. Such blindness may be explained (see Item 4), but explanation is not an excuse. It is difficult to forgive. The political and economic American elite did not even follow the reminding mandate of GATT, prescribing a country "to safeguard its external financial position and its balance of payments."
To control the deficit, a country may pursue a protectionist policy. In the USA, millions of people are mad as hell. Whoever will be the President of the USA in 2017, he or she will change the trading rules.
But let us not do it stupidly. Every purely protectionist policy shoots itself in the foot. Mr. Trump has threatened to put a 45 percent tax on Chinese imports "if they don't behave." Such policy would create a burden for the USA economy. Inflation and financial difficulties for a common Joe would follow. Senator Sanders probably would go the same way. Trade wars and retributions will follow. Ultimately, the WTO will forbid the tariffs. Well, the deficit country must be saved from both free trade and protectionism.
6. History of CFT. The idea that trade surplus countries should be somehow taxed to provide help to the deficit countries is not new. There exist many proposals of "managed trade," all requiring international cooperation and thus being no more than utopian wishful thinking. For instance, J. M. Keynes made such proposal in 1941. (The proposal was rejected because of resistance of the USA, then a surplus country.) The problem is - how to make the surplus countries to give up their gains? Which weapon can be effective, given the rules of the WTO and existing "eternal" trade agreements between countries? How to avoid long and futile haggling in re-negotiating such agreements? And after that, how to catch every trick and crime of experienced crooked traders?
In 2004 I hit upon an idea of a fundamentally novel, "balanced capitalism" compromise between free trade and protectionism; I called it "Compensated Free Trade" (CFT). (The absolute novelty of CFT was confirmed in 2009 by an expert in international trade Prof. Morici, who "never saw such a proposal.") I developed CFT in response to a 2004 article by Prof. Samuelson, allowing the possibility of dangerous trade results for the USA under conditions of dynamic technological change at its trading partners. (Gomory and Baumol expressed similar and other concerns in 2001 for a world where technological predomination of countries quickly alters.) I have sent my proposal to Samuelson. CFT substantially invalidated his HOS theory and, in terms of Thomas Kuhn, "shifted the paradigm" of international economics. Having no counter-arguments and being a gentleman, he wished me "Good luck" in his response. (I recently have sent the abstract of CFT to a couple of dozens of leading economists; not a single response.)
Since 2004, CFT was described in several publications (including some of my 2010 articles in my blog at Huffington Post) and presented at an international conference. In 2005, jointly with M. Perlman, The University Professor of Economics (Emeritus) of University of Pittsburgh, we submitted a statement on CFT to the USA Senate Finance Committee on hearing about US-China economic relations.
But I did not press for its being widely known - to the general population, not to the economists, who would try to keep it "Top Secret." Now, because of new importance of trade, I think it is time to make CFT the subject of wide discussion.
7. Some CFT Detail. CFT imposes the deficit control while largely avoiding its unpleasant consequences for the domestic economy. As stated in the very beginning of the article, the tables can be turned on the surplus countries by imposing separate annual limits on the individual deficits, derived from trade with each trading partner. The sum of these limits should not exceed the desired total trade deficit of the country.
The task of setting the deficit limits perhaps can be split between the branches of government: the Congress would set the overall annual limit for the country, while the President would allocate the limits between the trading partners. Detailed techniques of CFT should be derived in the process of its implementation.
A partner may go beyond its trade balance limit if its government pays the government of the deficit country the full amount of the excess deficit. Both the number and zeal of customs inspectors dedicated to accepting goods imported from a partner would depend directly on that partner's relevant behavior.
CFT is realistically unilateral. This is the main and crucial difference of CFT from all other proposals of "managed trade." No expectations of good will to dominate the negotiations. No wishful thinking.
A country can succeed in imposing such a policy unilaterally if its market is sufficiently attractive for its trading partners. The USA, the engine, and the last sap resort of the global economy, currently meets this requirement.
8. Following GATT. First and foremost, CFT strictly follows GATT and thus cannot be forbidden by the WTO. Article XII of GATT states that any country "in order to safeguard its external financial position and its balance of payments, may restrict the quantity or value of merchandise permitted to be imported." GATT says nothing about tariffs. In contrast, the WTO forbids tariffs but says nothing contradictory to Article XII.
GATT did not see how to safeguard the balance of payments other than by restricting imports. CFT goes straight to that goal by a better short cut - by splitting overall balance into trading partners' fractions and limiting these partial balances.
9. Containing the Dragon. Let us start with geopolitical advantages of CFT. According to the Prof. Mearsheimer of the "offensive realism" school of geopolitics, China can be considered as "threat number one" and the possibility of a future Sino-American war should not be excluded. In his "The Tragedy of Great Powers Politics" book (2014) he says that "Slowing down Chinese economic growth is certainly a more attractive option than nuclear war ..." but he does not consider it feasible. In his "Crouching Tiger" (2015) book, Prof. Navarro does not dispute Mearsheimer and states that the only way to deal with China is the "peace through strength" process. Do we follow it?
Each year, China increases its military budget by double digits percentage, and it is now somewhere between $200B and $300B. At the same time, we continue cutting our military budget. Our present Navy is headed down to 250 ships, which is less than a half of what it has been under President Reagan. The size of USAF is below demands of combatant commanders, is the smallest in its history, and will continue shrinking further under budgetary sequestration.
Meanwhile, as shown in Item 5 above, each year we cheerfully continue to pump over hundreds of billions of dollars from our defense to China's armed forces.
CFT can be used for containment, a la Kennan, of geopolitical adversaries of the democratic world order, such as China. And in the current situation, its territorial containment is impossible, while financial containment should be very effective. China's government fears unemployment, which may threaten social stability. Therefore the payments for excessive surplus would likely not to be forwarded to manufacturers of export goods, but be paid from currency reserves of the country. (They have shrunk to a five-year low of $3.19 trillion, but still are large enough.) That should reduce the China's military budget. Considering both the uncertainty about the China's intentions and the current conditions in the South China Sea, this is not bad.
The current slump of China's economy does not change the situation. In comparison with December 2015, as of May 1 2016 the China-USA trade-in-goods surplus decreased just by $6B, from $366B to $360B. As a matter of fact, we are now to request China to cut industrial output of several products. Moreover, according to Mearsheimer, slowing its growth is good for the USA. Maybe CFT is precisely the containment policy he is looking for.
10. Trans-Pacific Partnership Vs. a Vacuum. Trans-Pacific Partnership (TPP) has enormous geopolitical importance. It provides a cordon of 12 Pacific nation states against China's continental and global ambitions of expanding its sphere of dominance. It confirms "the pivot" of the USA to the Pacific. The geopolitical impact of TPP incomparably more important than its economic one: if America is out, China will be in - the Nature does not like vacuum. However, like any economic agreement, TPP provides both advantages and disadvantages for America. But if CFT is implemented, it would handle such issues as loss of American jobs. That would remove or lessen obstacles to the congressional approval of TPP and implementation of this agreement, crucial for stabilizing the influence of the USA in Asia.
11. Get Me a Couple of Hundreds of Billions. In the fist years of its implementation, constraining deficit limits should probably be decreased from the current deficit levels gradually. To avoid emotional overreaction of trading partners, we should not go too far. Nevertheless, with overall USA annual trade deficits of about $500B, even the initial USA benefits should be quite substantial.
12. Restoring the Internal Balance. Offshoring and globalization had destroyed the delicate balance between the three "countervailing powers" of labor, capital, and government (Prof. Galbraith 1952), created in the USA with enormous difficulties by the 1950s. Unbridled globalization undermines societies and is incompatible with democracy. In his 2011 book "The Globalization Paradox" Prof. Rodrik says that out of three - nation, democracy, and globalization - we can have any two, but not all three at the same time.
CFT would stimulate corporations to relocate their enterprises to the USA. At the same time, any trading partner would protect his existing domestic business from invasion of foreign enterprises, which another country could try for purposes of re-shipping or relocating its exports, since such attempts would compete for a part of the partner's deficit limits. In this manner, CFT would make that trading partner the ally of the USA in preventing limit evasion by other countries - and also help to restore American jobs.
In the cited above book, Rodrik describes a quite unexpected way in which CFT, in its constraining impact on globalization, would help to restore the social balance in the USA. America is a very open country - its average import tariffs are below 5 percent. In such country, it is extremely difficult to obtain further increase of market efficiency from additional trade liberalization: we need "... about $50 of [income] redistribution for every $1 of aggregate gain. It is as if we give $51 to Adam, only to leave Daniel $50 poorer." It seems that Adam belongs to the 1 percent, while Daniels constitute those tens of millions of Americans that are on the wrong side of trade effects. They suffer, by Rodrik, from 8 to 28 percent of wage decrease. Of course, if they find a new job. By Moore, "There are now more than 100 million Americans over the age of 16 that are not working." According to a new survey by the Council of Economic Advisers of the White House, the labor participation rate in America is now 62.6% - a low level, not seen since the 1970s. For American "prime-age men" (25 to 54) it is 88% - the third-lowest among the world's developed nations. (1n 1954, it was 98%.) Greece, Slovenia and Turkey have bigger rates.
In 2009, Prof. Blinder guesstimated the maximum number of "potentially offshorable" American jobs. He considers that "... sixty million is more than enough to create something akin to a new industrial revolution." That includes 100% of manufacturing jobs.
13. What Trade Wars? CFT seems to be the only system that would prevent trade wars and economic recriminations: since it imposes constraints not on the USA import from a country per se, but rather on our trade deficit (that is, on the difference between the partner's export to the USA and the American export to that country), any attempt to decrease the latter would also automatically decrease the former. That will put to rest all ill-boding parallels with the Smoot-Hawley tariffs and their allegedly ominous consequences.
For instance, suppose that our import from a country is $10B, while our export to that country equals $7B. The deficit limit for the country is set at $3B. If the country adopts some measure that decreases our export to $6B, its allowed export to the USA would equal not 10, but rather 6 + 3 = $9B.
14. At Last, a Free Lunch! Item # 4 mentions disregard of money as one of the main faults of the theory of international economics. In the second most important flaw, HOS contradicts the very essence of economics - it says that there is free lunch. A country is able to specialize without any adjustment costs; in the real world, these costs might easily bury "the advantage."
Even forgetting about the social costs of possible unemployment, HOS excludes -- among many other items -- the costs of re-training, relocation, and readjustment of workers of an industry that is liquidated. Since HOS deals with multi-industry models, this means that all those workers must be "homogeneous" jacks-of-all-trades, able at a day notice go full speed into any of the growth industries. Textile industry women of South Carolina, when their factories are closed, must start next morning at Boeing or Microsoft. Doing Windows or planes. Or the workers remain in SC, using next day the former textile machinery to produce these goods.
15. Top Secret - Your Daily Wage Is Going to Last a Month. As Rodrik says in his book, "Confronted by the gap between what they teach and what they preach, economists will take refuge in a number of arm-waving arguments. ... None is particularly convincing. ... [T]he ambiguity of the case for trade are well known within the professional economic community. The problem is that economists guard them like state secrets and look on those who would share them with ordinary folks as apostates."
For instance, even would the theory of international trade be correct, its projected results would be completely unacceptable to majority of Americans. These conclusions are therefore hushed up. For instance, it has been rigorously proven (in two "factor price equalization" theorems) that, even under full employment, and even if all theoretical and practical difficulties were "assumed away," wages in all free-trading countries would be equalized at a sufficiently low "weighted" level. Basically, importing goods is equivalent to letting in the workers that produced these goods.
Do not forget that wages in some countries are at least 30 times less that in the USA. (In 1999-2000 the US labor organizations demanded that US would not admit China into WTO without "addressing its systematic and egregious violations of workers' rights," in particular -- until its wages satisfy standards of international labor bodies. However, Clinton prevailed; W. Bush happily followed in his steps, patriotically exporting the US manufacturing base. Another example of "triumph of hope over experience." One of the worst and most costly triumphs in the history of mankind.)
Under persistent unemployment, and under the conditions of the new industrial revolution, it will be much worse than under full employment: in every category of labor, excessive supply will overwhelm any possible growth of demand. And, as pointed out by Blinder, education and skills may not help Americans because of an enormous pool of unemployed and less-paid professionals and skilled workers in the rest of the world. China alone needs 17 to 20 million new jobs a year, and -- for political stability - needs them badly.
16. Worse than New York Rats? Thank God, I am not an economist. I am an engineer-economist who builds tools. CFT is just a tool. It is simple to the max and does not need super-duper mathematical models and complicated computations - it needs only some political will in Washington. (Which may, however, be harder to obtain. If New York is infested by rats, Washington is infested by lobbyists. They are more dangerous, because they are global and because political will is their favorite dish.)
17. Summing Up. In the possible recession to be caused by Brexit, we still have to worry primarily about the USA trade deficit and restoring the order in the global market. The role of CFT needs yet to be discussed, but its importance remains valid. Who knows - CFT may be more needed in interesting times.
Tools of unique quality create enormous potential of opportunities. Geopolitically, CFT may contain adversaries and ease approval of TPP. It may improve the USA trade balance by hundreds of billions a year. It may put in order the global market. I also believe that the very versatility of CFT confirms that it is "a natural" and that this policy will be an integral part of any effort to improve chances of survival of both mankind and the democratic world order. CFT deserves an immediate serious discussion.
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