Tuesday, August 2, 2016

Lesson 13 Free Trade

I thought I knew the meaning of the words free trade. But listening to political dialogue these days I am more confused than Charlie Sheen at a lesbian AA meeting. I am mostly confused because some candidates say they are for free trade and then they explain why they oppose actual attempts to make trade freer. It is like you saying that you are for motherhood, but you think that women should not be allowed to fertilize their eggs. Wow – this is supposed to be a family blog and I used the word fertilize. I apologize.

You don’t have to have a PhD in meteorology to know that free trade is a desirable outcome. Can you imagine people protesting with big signs in favor of Not-Free Trade? It sounds pretty weird. We like things that start with Free. Like Free Love. What could be wrong with that? Then there is Free Enterprise. Free is the first four letters of the word freedom.

When I was a little economist with long pants and an Adam Smith tie I learned that free trade was a really good thing. Imagine free trade within your borders. Free trade means that Charlie can produce rose hip wine for Pete and Pete can sew doilies for Charlie. Both Pete and Charlie are made better off because Pete is lousy at making wine (he drinks more than he makes) and Charlie couldn’t sew his way out of a Goldman Sacks bag. Letting these two lovely fellows trade makes them both happier and richer.

The same basic idea can be applied to Paco and Juergen. Paco lives in Barcelona and Juergen lives in Germany when he is not globetrotting. Paco can make wonderful paella and Sangria and Juergen can produce machines and large spears of white asparagus (in the spring). They trade and both are made better off.

All that seems pretty clear. But economists can’t stand it when easy ideas don’t have complicated names and mathematical formulas – so they call this process comparative advantage. You could read a chapter in an economics book called comparative advantage and then want to kill yourself. But believe me, it is easy stuff. It explains why you don’t make your own t-shirts and why you’d prefer to buy one from the local t-shirt shop or maybe one made in China. The cool idea is that whether you buy the t-shirt (that says I sat by the window at the Mucky Duck) from Bloomington or China, you are not making the shirt yourself! Someone who knows how to make a really good shirt is making it for you. Apparently you are pretty good at making something else.

So what’s the problem? The problem is that in the real world there are three parties. Genevieve has been making t-shirts for three years. Along comes Nolan and he decides to make t-shirts too. Nolan's t-shirts glow in the dark. Brendan quits buying Jen's shirts and buys Nolan's shirts. Jen's business is threatened. Jen’s class erupts into chaos at their scheduled kickball time and begins chanting down with Nolan slogans.

The problem with free trade is that it advances mankind. You read that right. Free trade is all about free choice – freedom to replace one thing with another. We replaced the horse with the auto and the tractor. We quit eating fatty ribeye steaks and replaced them with corn on the cob and Brussel Sprouts. We threw away our wonderful phonographs and now use Spotify. Enough? Every one of those choices has a plus and a minus, but most of the choices make us all better. Proof? I don’t see many of you wanting to replace your new electric vehicle with a horse named Nathan.

Society does not like it when some people suffer. Society especially doesn’t like it when the person hurting seems to be suffering because we made a choice for a foreign-made product. There will always be a constituency that wants to help neighbors who lose jobs and income and careers because of either domestic or foreign competition. But don't forget. Helping these people means you restrain the benefits of trade and are hurting others. 

So that gets me to free trade agreements. FTAs are ways to promote free trade. That means removing or reducing tariffs or other obstacles that discourage trade across borders. FTAs encourage those positive results I wrote about above. My Google search says that the US has FTAs with 20 countries. Among the 20 are Australia, Canada, Israel, Korea, Mexico, and Singapore. We are contemplating more FTAs with Pacific countries and Atlantic countries. And while our candidates say they are proponents of free trade, they are also saying these new agreements are not good and Mr Trump says he might want to rip up some of those 20 we already have.

How do we get the benefits of free trade without FTAs? The answer is that that we don’t. Keep in mind that when countries negotiate a new FTA they require each country to do something to improve access to their markets. They might reduce a tariff or eliminate a quota. They might change a regulation that purportedly changes food safety or labels or names of products. There are many ways that countries protect themselves from the benefits of trade. Thus there are many ways to reduce those protections and encourage freer trade.

Our candidates are stepping back from these FTAs and are saying that we opened our economy more than our partners did. And thus our partners got more of the benefits of trade than we did. But keep in mind these points. First and foremost – all parties benefited from freer trade. Second, it is impossible given the diversity among the partners and the multitude of ways trade impacts a nation to insure that each country gets exactly the same benefits. Third, as in my examples above, all countries create losers in the process of opening up trade.

Free trade helps us. FTAs are the best way to keep expanding these benefits. Some politicians will point out the imperfections of these FTAs but any move away from free trade is going to hurt us. If I had my equations with me I could prove this with math. 


  1. G’day, dear LSD. FTA has been promoted as good. FAFTA (no, not NAFTA) would be better . . . free and fair trade. Trading countries anticipate each partner will receive fair and “equivalent” value. But since humans conduct the negotiations they know they really can’t trust the terms will be honored. The evidence of that is governing bodies, such as the WTO, which among other stuff “oversees,” “ensures,” and “settles disputes.” However, overseers such as the WTO lack effective enforcement capabilities (other than a slap on the wrist) and some parties to agreements simply ignore the governing bodies. I don’t see an improvement in that matter any time soon.

    Your point that all partners lose something is proven; some more so than others. My backward looking time-kaleidoscope shows richer countries (developed, western,) lose more relatively and actually than poorer countries (developing, mainly eastern), resulting in the richer countries’ standard of living diminishing and the poorer countries’ SOL improving. In current lexicon this describes a massive transfer of wealth. I don’t think Ricardo envisioned that; I don’t see an improvement in that matter any time soon.

    It seems that to off-set/counter that trend that Charlie should produce more rose hip wine and Pete more doiles to boost their GNP and presumably their SOL. But, any good economist would point out that the degree of success for that solution would depend on the demand for and ability to pay for the additional output. Maybe not a shure-thing solution.

    Another factor affecting the stabilization/improvement a country’s SOL (and balance of trade) in the context of FTA is its success in continually readjusting/managing its human, technological, financial, (military?), basic and natural resources, etc. to maintain and/or improve its overall competitive situation. Hm-m-m-m, seems like fix’n FTA to effect the desired outcome will require more than simply re-negotiating FTAs and implementing FAFTAs.

    All said, it appears the trend of a massive shift of wealth from richer countries to poorer countries and degradation of SOL in the former will continue (e.g. the middle class in the U.S. even though its SOL relative to poor countries is luxurious). Given I lack a PhD in meteorology I can reasonably say that free trade has not proven to be a completely desirable outcome—unless you live in one of the poor countries.

    That FTA is good and advances mankind is arguably true on the macro level, but on the micro level I doubt even re-negotiated FTAs enforced FAFTAs would impede/reverse the trend. I don’t see an improvement in that matter any time soon.

    1. Dear Senior Tuna,

      Much of what the WTO agreed in the past has been followed. Many tariffs were lowered and most quotas were ended. At the margin they are not very good at policing dumping and property rights. But this is sticky stuff. I too doubt they can correct those issues.

      Your point about poor countries benefiting more than rich ones from FTAs is not one I know about. But then, you may be confusing cause and effect. Some emerging market economies have grown rapidly but it has more to do with putting in transformational policies that moved them away from socialism and/or dictators. Also, since they started from a very low base, their records of growth will look pretty impressive. It is easy to show large gains when you are growing from a small and inefficient base. Richer countries are kinda stuck with 2-3%. Sadly most rich countries seem to care more now about redistribution and less about growth and efficiency. So inevitably growth will continue to be slow despite the possible benefits of freer trade.

      Not sure what you mean by micro. My blog is totally about macro.

      Walking away from FTAs will make the USA a less competitive place. In the end we will have to deal with foreign competitors. We need to sharpen our edges -- but most of what I see will make us weaker competitors and will likely call for even more rounds of protectionism. Not a nice cycle.

    2. Dearest LSD. My point that poor countries benefit more than richer countries is evidenced by our trade deficit—though the majority of our deficit is with major partners like Canada, Mexico, Germany, and Japan who are not poor. I expand my point beyond poor countries to say most of our trading partners benefit more than us—and based on that I cannot say we’re better off. And, yes . . . poorer countries will benefit more simply because they start with little. My use of micro/macro: I agree on a macro level trade is/should be mutually beneficial but on a country/country micro level benefits are not equally beneficial. As you say, there will be winners and losers—on a macro level the U.S. trade deficit does not suggest a benefit and at the middle class micro level it’s been a disaster. Capeesh?

    3. Hi Tuna,

      There is no real direct evidence that FTAs have been a disaster. Studies I have seen lay most of the blame for employment displacement on industrialization. But call it what you will -- the problem is the world is changing and we are not changing our skills fast enough to get the most benefit. And the trade deficit is not a measure of the benefits of free trade. Some countries need to have surpluses and some need deficits. At the turn of the century the US had huge deficits as we imported much needed capital to build our infrastructure. Most people say that was a good thing. The balance in the current account or trade deficit is only part of what goes on in international trade. Note that we have a surplus in our financial and capital account. If future leaders would focus on labor supply and productivity and not worry about trade deficits we would be much better off.

    4. Showing my age -- turn of the century referred to the turn from the 19th to 20th. Geesh, where did that next 100 years go?

  2. Dear Charlie Sheen, we have over 200 years of experience that free trade is more productive than free love-- for example the baby boomers didn't produce many kids. Countries that learn how to trade and learn how to help those who are hurt by trade are far better off than countries that just build walls and try to protect industries.

  3. Personally, I think "free trade" is a misnomer. There still ain't no "free" lunch. Somebody always wins, somebody always loses. As with "free love," there's always a price to pay.

    1. I thought you agreed with the adage of a rising tide lifts all boats? This is not much different. Free trade lifts all boats -- maybe not by the same amount but upward anyway.

  4. 'splain that to the displaced workers beginning 'round the 70s, the creation of the Trade Adjustment Assistance Program, and folks in the middle class who are out of work. How much due to technology, innovation, and just plain ol' ferign products entering our markets?

    1. Tain't easy to 'splain dear Tuna. But I can explain what happened after the Smoot Hawley Tariff. I am not a politician so I can say things like -- trade almost always has winners and losers. It takes a lot of careful work to figure out the net effect of trade. I look at a body of evidence and come away believing trade was beneficial. Someone else may disagree. Its hard to referee especially in times when people want to be so ideologically pure.