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Debating Free Trade vs. Protectionism

One of the leading global economic factors that will determine who survives the current malaise is the manner whereby states engage in trade with one another.
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Playing with Fire
William J. Bernstein

"When goods are not allowed to cross borders, soldiers will." --Frederic Bastiat

How soon we forget. For nearly all of recorded history before 1945, Europe, today a peaceful and prosperous region linked by high-speed trains and ridiculously low airfares, was riven by nearly continuous major conflicts. In the Second World War's aftermath, it was crystal clear to military, political, and diplomatic leaders on both sides of the Atlantic that the trade protectionism of the previous several decades in no small measure contributed to that catastrophe.

The U.S. State Department said, in effect, "never again" and drew up a blueprint for the new world trade order, Proposals for the Expansion of World Trade and Employment, which soon gave rise to the GATT and the beginnings of the EU. The arrangement succeeded beyond its wildest expectations and ushered in an era of unparalleled global peace and prosperity.

By 1945, the link between trade conflict and armed conflict had become blindingly obvious. This was nothing new, of course. The Peloponnesian War saw its genesis in Athens' dependence on the grain from what is now the Ukraine, which necessitated control of the narrow passages between the Aegean and Black Seas by the Athenian Empire.

In the early seventeenth century Holland and Portugal fought a remarkable world-wide conflict over the trade in slaves, spices, and sugar. Later in the seventeenth and eighteenth centuries, Britain and Holland fought no less than four wars, sparked largely by British protectionist legislation--the Navigation Acts.

Southern anger over northern protectionism contributed to the outbreak of the Civil War nearly as much as did slavery. Those who doubt this would do well to consider that just thirty years before, the two sides nearly went to war over the Nullification Crisis of 1833, which was itself directly precipitated by the tariff acts of 1828 and 1832.

Mr. Fletcher tries his best to ignore this historical inevitability of retaliation to tariff increases; he asserts that since our trading partners, particularly those in Asia, run persistently high trade surpluses vis-a-vis the U.S., they would not dare retaliate.

There are at least three things wrong with this argument. First, in the past, it hasn't worked. During the 1930s, for example, all nations, including those running trade surpluses, pushed up their tariff rates. Second, it ignores one of the prime lessons of human history: winners often do not remember, while losers never forget. Centuries of humiliation by the West have scarred the national psyches of both China and India, and serious misunderstandings can easily ensue. Who controls the Strait of Malacca, through which flows China's oil supply and European trade? The U.S. Navy.

Last, Mr. Fletcher believes that our politicians can fairly dispense protection broadly across the economy by means of a "flat tariff." Good luck with that: U.S. trade preferences always have, and always will, go disproportionately to the prosperous and well connected. Exhibit A: the obscene sugar subsidies and trade preferences meted out for decades to the wealthy and powerful Fanjul brothers.

Do not be misled by those whose naive belief in the rational self-interest of others will prevent any significant protectionist actions by the United States. The events of August 1914 demonstrated just how seriously awry the "rational self-interest" of nations can go, and the Cold War taught us the impossibility of containing even the smallest of nuclear exchanges. So too has history repeatedly shown that even small tariff increases often lead to trade wars, and that trade wars can end in Armageddon.


The Ten Flaws in Free-Trade Economics

Ian Fletcher

Let's crack open the intimidating "black box" of free trade's supposedly irrefutable economics.

The first problem with free trade is that conventional arguments for it are about GDP. But GDP is not identical with material well-being. Whenever someone breaks a window or gets a divorce, GDP goes up. So even if free trade economics were 100% valid (it isn't), free trade would still not necessarily be best.

The second problem is externalities, or when economic value is created or destroyed without a price tag. Negative externalities like environmental damage are well known. Less well-appreciated in the U.S. are positive externalities, like the way some industries open up paths of growth for the entire economy. Free trade can wipe out these industries because it ignores this hidden value.

The third problem is the assumption trade is sustainable. A nation exporting non-renewable resources may discover that its best move (in the short run) is to export until it runs out. The flip side is overconsumption, in which a nation (like the present-day U.S.) borrows from abroad and sells off assets in order to finance a short-term binge of imports that lowers its long-term living standard. Free trade economics defines both these problems out of existence by conceiving economic efficiency as merely the optimal satisfaction of consumer preferences, so if consumers want a short-term binge, then free trade is "efficient."

The fourth problem is the assumption that free trade does not increase income inequality. If it does, free trade may benefit the economy as a whole yet harm most people in it. Free trade tends to raise return to the abundant input to production (in America, capital) and lower returns to the scarce input (in America, labor), so it benefits capital at labor's expense.

The fifth problem is the assumption, in the all-important theory of comparative advantage, that factors of production (especially capital) are not mobile between nations. This theory says free trade will reshuffle a nation's factors of production to their most productive uses. But if factors of production are internationally mobile, and their most-productive use is in another country, then free trade will cause them to migrate there--which is not necessarily best for the nation they depart.

The sixth problem is that this theory assumes factors of production are mobile within nations. Unemployed autoworkers become aircraft workers, and abandoned automobile plants turn into aircraft factories.

The seventh problem is that this theory assumes the economy is always operating at full output, or at least that trade has no effect on its output level.

The eighth problem is that this theory assumes short-term efficiency is the origin of long-term growth. But economic growth is about turning from Burkina Faso into South Korea, not about being the most-efficient possible Burkina Faso forever. History has shown that the short-term inefficiencies of a prudent tariff are more than compensated for by the long-term spur to industry growth it can provide, largely because growth has more to do with the industry externalities mentioned above than short-term efficiency per se.

The ninth problem is that this theory merely guarantees (if true) there will be gains from trade. It does not guarantee that changes induced by free trade, like rising productivity abroad, will cause these gains to grow rather than shrink. So free trade can strengthen our rivals.

The tenth problem is that, in the presence of scale economies, the perfectly-competitive international markets assumed by the theory of comparative advantage do not exist. Instead, outsize returns accrue to nations that host global oligopoly industries. And free trade will not necessarily assign any given nation these industries.

Ian Fletcher is an Adjunct Fellow at the San Francisco office of the U.S. Business and Industry Council, a Washington think tank founded in 1933. He is the author of Free Trade Doesn't Work: What Should Replace It and Why. (USBIC, $24.95)

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