The Limits of Free Trade

Others, among them many China critics who cannot be accused of covert protectionist leanings, disagree. To them, trade is merely one in the arsenal of weapons to be used to implement the nation’s foreign policy. Listening to this debate, the public seems to have decided that both protagonists are right: It votes with its dollars in favor of the free trade that brings cheaper goods to its shopping malls, and simultaneously tells pollsters that trade restrictions are sometimes necessary to protect specific industries, or to “get even” with countries that misbehave towards the United States.

Start with an undeniable fact: A good part of the post-World War II prosperity and economic growth is attributable to the liberal trading regime erected, step by step, after the war by a combination of American policymakers and Britain’s John Maynard Keynes. Columbia University’s Jagdish Bhagwati contends that his study of data relating to trade, income, and other economic variables establishes “the overwhelming probability that diminishing trade barriers were a major contributory force in the postwar expansion of incomes.” And Federal Reserve Board chairman Alan Greenspan contends that “the dramatic increase in world competition — a consequence of broadening trade flows — has fostered markedly higher standards of living for almost all countries that have participated in cross-border trade, . . . most especially the United States.”

The mechanism by which elimination of tariffs and other barriers to trade contributes to the wealth of nations has long been understood. Adam Smith summed it up by saying, “If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.” Free trade permits each country to do what it does most efficiently, and to trade that lowest-cost output for the goods of other countries specializing in what they do best. What writers today would call a win-win situation.

Writers, that is, who are not troubled by serious doubts about where such reasoning leads, doubts that immediately trouble policy types, who see freer trade as only one of many objectives of national policy. America now trades fighter planes for Middle East oil, an economically sensible arrangement, given the fact that Middle Eastern countries could not develop an aircraft industry except at exorbitant cost, and oil produced in the United States probably costs at least ten times as much as oil from the sands of Saudi Arabia and other Arab countries. Win-win, surely. Or at least until the Arab countries decide to unsheathe what they call the oil weapon, and deny America access to their relatively cheap oil unless it tailors its foreign policy to the desires of the anti-Israel oil producers.

Similarly, Americans happily snatch from store shelves the low-cost sneakers and T-shirts that flow from China into the nation’s malls, at one and the same time saving vast sums that would otherwise be spent on costlier made-in-the-USA shoes and garments, and helping impoverished Chinese workers begin the long ascent to Western standards of living. Win-win, surely. Until the Chinese use the technology we have exported and the fruits of their enormous trade surplus with America to make possible an arms build-up that threatens America’s Asian allies, and requires us to beef up our military presence in the region.

Serious policy types also worry that free trade creates losers as well as winners. It benefits consumers while, at times, harming some workers and investors. Cheap steel from Korea may make various household goods cheaper for consumers, but it plays havoc with the paychecks of American steel workers. Cheap labor imported from Mexico may keep the cost of maintaining a Beverly Hills swimming pool lower than it would otherwise be, but it also demonstrably depresses the wages of unskilled Americans and, in times of less-than-full employment, threatens their jobs. Imported automobiles may be a boon to consumers, in no small part by putting pressure on domestic manufacturers to keep prices down and quality up, but they are unwelcome threats to the wages and benefits of American auto workers. Unless one is prepared to argue that there is some ethical reason why consumers are to be given preference over producers when making policy, this clash of interests must somehow be taken into account in formulating trade policy.

Joy at every trade-opening move is not bounded only by worries that such advances, albeit clearly in America’s overall interest, create some losers. It is also mitigated at times by the feeling that easier access to the huge, affluent American market is a gift not to be bestowed on the unworthy. In this view, the promise of freer trade with America is an important policy tool for use in a wide range of circumstances: Access to American markets can be used as a carrot to get other countries to do things that we want them to do, and as a stick to get them to stop doing things that we don’t want them to do.

True, if we deny others the benefit of access to our markets we are depriving our consumers of access to the most efficiently produced goods the world’s producers can offer, but there are times when the sacrifice of that benefit is in the broader national interest, or in the interests of preserving some of the values that Americans see as their obligation to export to other, less fortunate nations. Because the benefits of trade are unevenly distributed, and because other considerations can be more important than increasing the efficiency of the international economy, even free-trading presidents at times have strayed from the straight and narrow. Some, it is true, bow to parochial protectionist pressures to win the votes of congressmen. But others have grander motives, such as the need to protect a key defense industry; or workers caught in the gale of international competition, now more commonly known as globalization; or the need to make it clear that treading on us can have serious consequences because we Americans do not live only to maximize the flow of goods and services in international commerce.

Complaints about the economic inefficiencies of such policies are, in the end, quite beside the point. If the people, speaking through their elected representatives, decide that forgoing cheap T-shirts is a small price to pay in order to deny support to a regime that has a repugnant human rights record, that is for them to decide. If a political decision is taken that it is somehow unfair to ask American firms to compete with subsidized foreign competitors, even if those subsidies represent wealth transfers from the taxpayers of the subsidizing nation to American consumers, that decision is in no sense irrational. It may be bad economics, but that does not automatically make it bad public policy. If nothing else, a sense that trade is “fair” as well as efficient is necessary to retain political support for ever-freer trade.

None of this is to say that economic considerations are irrelevant to the formulation of a trade policy that serves the national interest. Indeed, so significant are the benefits of free trade that policymakers should bring a bias in its favor to their work. This is important if for no other reason than that the producers who benefit from protectionism are concentrated and know who they are, while the consumers who benefit from free trade are diffuse and often not fully aware that their cost of living is being reduced by lower-cost imports. The resultant disparity of political power puts a responsibility on policymakers to enter the trade debate with a presumption in favor of the liberal trading regime that not only maximizes the availability of more efficiently produced goods from overseas, but puts pressure on domestic producers to become and remain efficient.

One need only recall the price and quality of home-made automobiles before the Japanese cracked the U.S. market, compared with the variety, quality, and prices now available, to understand these benefits.

When the presumption in favor of free trade is tested against the facts of specific pleas for exemption from its rigors, policymakers can use some help in deciding which cases warrant protection or special treatment, and which do not. Here, economists come in handy. They can compare the costs and benefits of policies aimed at redistributing income from producers to consumers by supporting freer trade, and from consumers to producers by restricting the movement of goods and services in international commerce. The Bush administration, rumor has it, is preparing to grant special protection to the steel industry, either because “cheap imports” have produced a spate of bankruptcies, or because it wants steel-state congressman to vote to restore fast-track authority to the president. Such a move might make sense if it costs consumers (including domestic industries that use steel in their products), say, one billion dollars, but not if it costs them ten times that.

In any case, it is important to seek the cheapest solution to any trade problem that cries out for solution. In Britain, for example, it proved cheaper to grant generous lump-sum pensions to coal miners than to protect them from foreign competition or competition from other fuels. In America, to cite just one example, it might well prove cheaper to pension off beet sugar growers than to continue to protect them from imports of far cheaper cane sugar.

This sort of economic rationality has its uses, too, in the debate over the relation of trade to other issues. The China issue provides a perfect example. Were we to close our markets to Chinese goods — a practical impossibility given the difficulty of determining the origin of many products — we would have to bear some costs: higher prices for some consumer items, the possibility that China would retaliate by closing the few cracks through which American firms have managed to slip some goods and services into China, and the loss of such benefits as might be associated with a policy of engagement. Before deciding between satisfying our natural inclination to freer trade, and our desire to use access to our markets to induce China to modify some of its domestic policies and its aggressive foreign policy, we should appraise the costs and the benefits of each of these policies. That calculation can inform policy. But it cannot determine policy.

For a decision to move away from freer trade might be costly but nevertheless in the national interest. Once again we can turn to Adam Smith, no protectionist, he, for guidance. Smith argued that it might be appropriate to grant relief from foreign competition to industries that face a heavy burden of taxation, which today we can reasonably interpret to include the costs of environmental and other regulations in instances in which the costs of those regulations exceed their benefits.

He argued, too, that national defense considerations — in the case of Britain the preservation of the large fleet on which its defense and ability to import necessities depended — make protection desirable. “Defence,” he wrote, “is of much more importance than opulence.”

And Smith even anticipated modern-day arguments that considerations of fairness justify retaliation “when some foreign nation restrains by high duties or prohibitions the importation of some of our manufactures into their country.” Smith saw such retaliation as an instrument that just might induce the offending trading partner to mend its ways. And never mind the economist’s argument that such a move is equivalent to shooting oneself in the foot by denying consumers access to the goods of the protection-minded country.

So freer trade is not an absolute good in all cases. It unquestionably adds to national wealth. But such enrichment is not a policy goal to be elevated above all others. For there is more to a nation than its GDP. When our then-minister to the French Republic, Charles Pinckney, said that we as a nation are prepared to pay millions for defense but not one cent for tribute, he was telling his countrymen that the economist’s cost/benefit computations are at times quite properly trumped by considerations of national interest and pride. He was right two hundred years ago, and the policy he enunciated remains right today. The national interest has as a component, and an important component, the maximization of the wealth of the nation. And freer trade, an important contributor to the increase in that wealth, is worth fighting for in the vast majority of cases. But, like all other policies, it is best seen as only a part, albeit an important part, of a variety of policies designed to secure our national interest.

Contributing editor Irwin M. Stelzer is director of regulatory studies at the Hudson Institute and a consultant to AT&T, News Corp., and several energy companies.