by Ian Fletcher
Free Trade Doesn’t Work
What Should Replace It and Why
by Ian Fletcher
Kindle Edition
Published by the U.S. Business & Industry Council
512 C St. NE
Washington, DC 20002
Copyright © Ian Fletcher 2010
All Rights Reserved
ISBN-13: 978-0-578-04820-8
freetradedoesntwork.com
usbic.net
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In Bangalore…I [was] standing at the gate observing this river of educated young people flowing in and out...They all looked like they had scored 1,600 on their SATs and I felt a real mind-eye split overtaking me. My mind just kept telling me, ‘Ricardo* is right, Ricardo is right...’ But my eye kept looking at these Indian zippies and telling me something else.
— New York Times columnist Thomas L. Friedman, The World is Flat, p. 264
*David Ricardo (1772-1823), British economist who formulated the theory of comparative advantage, cornerstone of free trade economics to this day. See Chapter Five below for why Ricardo was wrong.
CONTENTS
Foreword
Introduction: Why We Can't Trust the Economists
PART I: THE PROBLEM
Chapter 1: The Bad Arguments for Free Trade
Chapter 2: Deficits, Time Horizons, and Perverse Efficiency
Chapter 3: Trade Solutions That Won’t Work
Chapter 4: Critiques of Free Trade to Avoid
PART II: THE REAL ECONOMICS OF TRADE
Chapter 5: Ye Olde Theory of Comparative Advantage
Chapter 6: The Deliberately Forgotten History of Trade
Chapter 7: The Negligible Benefits of Free Trade
Chapter 8: The Disingenuous Law and Diplomacy of Free Trade
PART III: THE SOLUTION
Chapter 9: Where Does Growth Really Come From?
Chapter 10: The Multiple Equilibrium Revolution
Chapter 11: The Natural Strategic Tariff
Chapter 12: The End of the Free Trade Coalition
Bibliography
Praise
About the Author
Foreword
by Edward Luttwak
Until the economic debacle of 2008, the power and moral authority of the United States were sustained not only by its political values, cultural magnetism, and military strength, but also by its wealth. From its investment capacity as home of the world’s most sophisticated financial system to its purchasing power as the world’s largest importer, the U.S. had an undoubted primacy. When the latter finally ruined the former—for huge trade deficits tolerated for decades must decapitalize as well as deindustrialize—American diplomacy suddenly had to function without much of its accustomed leverage.
Some Americans have always been displeased by the magnitude of American power, probably because they project onto the nation at large their own moral discomfort with its exercise. For them, as for assorted dictators, Islamic fanatics, and the few serious communists still breathing, the present weakening of the United States is welcome. But for others, including this writer, this weakening provokes an unwelcome question: how much power can the United States retain without this leverage? And what kind of Hobbesian world order will we face in its absence? Whatever complaints of competence or intent one may lodge against this power, the world contains alternative hegemons with far fewer scruples. A weakened American economy will embolden the enemies not only of the United States, but of a stable world generally—especially in Latin America, the Middle East, and East Asia.
One early sign of America’s weakening economic leverage was the refusal of allies like France, Germany, Italy, and the Netherlands to cooperate with the expansionary measures of the newly arrived Obama Administration in early 2009. With global economic activity sinking as declining demand dragged down production, further reducing demand, only a Keynesian jolt of public spending or tax cuts could break the downward spiral. This much was agreed by all serious players, but every major European government save Britain refused to join with the United States in implementing such measures. Instead, they tacitly proposed to let others carry the burdens of reflation—mainly increased public debt and inflation risk—knowing full well that their own exporters would nonetheless benefit from the resulting increase in global demand.
Above all, these allies could not be brought to heel with the threat of tariffs, quotas, capital controls, or other protectionist measures. This was America’s natural card to play, but ruled out by an elite consensus rigidly opposed to any form of protectionism. This consensus—unshared with ordinary voters—prohibits even the milder forms of protectionism permitted under international agreements. Instead, it has a puritanical horror of the very concept which refuses to view protectionism as just another form of economic realpolitik, to be coldly evaluated according to its merits and costs. Instead, it is seen as a repudiation of the twin cardinal virtues of competition and openness.
This is a fact of which both America’s friends and enemies are well aware, and upon which America’s commercial rivals base their own neomercantilist trade policies. The result has been a prolonged failure to safeguard the American economy, especially manufacturing, from foreign predation. The most obvious tactic here has been currency manipulation, but this is only the tip of an iceberg whose size America’s rulers still do not appear fully to comprehend. This currency manipulation, involving as it does a tidal wave of cheap foreign capital propping up the dollar by soaking up American debt and assets, has in recent years helped keep interest rates in the U.S. abnormally low. It thus helped enable the speculative property and mortgage bubbles which led to the financial collapse of 2008. Thus many of America’s recent economic problems, both visibly trade-related and otherwise, are ultimately linked with an underlying trade problem.
This book, unlike many previous critiques of free trade, is no mere sulk about the harsh realities of capitalism or an extended analytical misunderstanding of what those realities are. Ian Fletcher, in fact, unequivocally favors capitalism—if perhaps more broadly shared in its prosperity, more Fordist (as in the $5 day), less dogmatic about free markets, better supported by industrial policy, and less decadently plutarchic than today. He favors free markets wherever the evidence vindicates them. These remain the sovereign cure for mediocrity and sloth, whose dynamism creates wealth and compels improvements in management, production, and distribution. Free markets stimulate innovation, the ultimate root of economic growth. All these facts this book comprehends, which should slow its dismissal by the usual suspects.
Devotees of free trade celebrate its advantages for American consumers. These are real enough. And even industry-destroying free trade can sometimes do good, by shutting down inefficient domestic production that misuses labor and capital, freeing up resources for the industries of tomorrow. But free traders celebrate these advantages and then just stop, as if Americans could be consumers and nothing but, and as if destroying obsolete industries did not beg the question of what is to replace them. The vitality of America’s underlying industrial base is either ignored or papered over with questionable economic theory—if not sheer ideological hectoring.
This is where Fletcher comes into his own, for he pries open the dogmatic black box of received trade economics. Despite the myth that serious economics vindicates free trade simpliciter, he shows in meticulous detail how the mechanisms which supposedly vindicate unlimited free trade under all circumstances are in fact dubious intellectual contraptions predicated upon unrealistic assumptions. The presumption of free and unmanipulated currency markets is only the most obvious example; there are many others. Fletcher also elucidates recent theoretical breakthroughs
in economics that are finally bringing realism into the doctrinaire mathematical world of academic trade economics, advances that are undermining the intellectual respectability of conventional free trade theory as now commonly understood.
These days, some of the leading practitioners of free trade, the chief executives of the largest U.S. corporations, are also quietly starting to reverse course. They, too, now proclaim that the United States must manufacture more and export more manufactured goods. Certain well-known firms are bellwethers of this change. For example, over the past 15 years, Boeing executives made many a speech celebrating the globalization of their company’s manufacturing operations. They tirelessly invoked free trade’s logic of comparative advantage to explain why they dismissed American engineers and production workers while Boeing’s risk-sharing partners were increasing employment overseas. They strove to impress Wall Street analysts with their periodic downsizings of thousands of workers at a time. These efforts to transfer manufacturing and design overseas were crowned in the 787 Dreamliner, whose wing box and wings were made in Japan and whose composite fuselage was mostly made in Italy—leaving little for the United States but final assembly. That overseas production might be cheaper merely because of subsidies by foreign governments seeking a foothold in this lucrative and strategic industry was irrelevant to Boeing, which is not responsible for the economy at large, but merely a business run for profit.
But Boeing’s self-congratulation came to a sudden halt when the entire 787 program was crippled by devastating development delays, most caused by gross manufacturing errors overseas. The company had to change course drastically to survive, promising Wall Street analysts to bring much design and production back to the United States. With less public drama, General Electric has also changed course: after investing vast amounts in overseas manufacturing plants, America’s single greatest industrial corporation is now strengthening its domestic manufacturing base and its chief executive, Jeffrey Immelt, has been publicly explaining why the country as a whole must do the same.
The reality is that manufacturing is inescapable. Few Americans can work in elite fields like corporate management or investment banking, no matter how large these loom in the consciousness of the governing class. Most service employment, such as restaurant work, pays low wages. Agriculture is a miniscule employer in all developed nations. And for all the glories of high tech, it remains a modest employer: during the auto industry wreck of 2009, Americans discovered that Ford, General Motors and Chrysler, despite of decades of decline, still employed more people than all the famous names of Silicon Valley—from Adobe to Yahoo—combined. As a result, the incomes and living standards of nonpoor Americans must largely rise and fall with manufacturing employment. Even if they do not personally work in manufacturing, a strong manufacturing sector is needed to support the labor market and the value of the dollar on which an import-dependent America now relies for its standard of living from garments to gasoline.
A new American economy is emerging, in which Americans will consume less and save more to rebuild America’s capital base, and import less and export more to start retiring America’s now-vast foreign indebtedness. (Indeed, America must do these things unless it intends to confiscate foreign dollar holdings by devaluation.) And it is hard to imagine how America can rebuild its manufacturing and rebalance its trade without repudiating free trade—to some carefully chosen extent. If nothing else, the need to neutralize foreign mercantilism demands this.
This is not just a matter of concern for Americans, because unless foreign demand increases, the global economy must shrink in proportion to falling American demand. So increased American exports are, in fact, the only way to maintain current American imports and thus global demand. It is thus that a dose of American protectionism may soon be precisely what the whole world needs.
Edward Luttwak, PhD
Chevy Chase, MD
November 2009
Dr. Luttwak is the author of Turbo-Capitalism: Winners and Losers in the Global Economy (1999) and The Endangered American Dream: How to Stop the United States From Becoming a Third World Country and How to Win the Geo-Economic Struggle for Industrial Supremacy (1993).
Introduction
Why We Can’t Trust the Economists
Oh yes, I know, we have recently been told by no less than 364 academic economists that such a thing cannot be...Their confidence in the accuracy of their own predictions leaves me breathless. But having been brought up over the shop, I sometimes wonder whether they pay back their forecasts with their money.
—Margaret Thatcher, 19811
America’s trade deficit. $696 billion in 2008. $701 billion in 2007. And a world-record seven hundred and sixty billion dollars in 2006.2 Even if it did fall by half in 2009—a temporary plunge seen in past recessions that probably doesn’t signify underlying improvement—a $370 billion deficit is still astronomical by any reasonable historical standard.3
To be fair, the trade deficit is not a perfect indicator of free trade’s cost. A nation can always balance its trade by crude measures like forcing down wages by political fiat. So, hypothetically, we could have a small deficit and a large trade problem. Plenty of impoverished Third World nations have balanced trade, and a single year’s deficit means nothing. But with numbers this high, the deficit is obviously a big problem if it’s a problem at all.
And yet Americans remain afraid to do anything about it. The dangers of protectionism are notorious, and questioning free trade in an intellectually serious way runs into deep waters of economics very fast. So we remain paralyzed in the face of crisis.
This book aims to loosen that paralysis a little.
Over the last 20 years, Americans have bought over $6 trillion (that’s trillion with a “t,” six thousand billion, six million million) more from the world than we have sold back to it.4 That’s over $20,000 per American. Ironically, if the U.S. were a developing country, our deficits would have reached the five percent level that the International Monetary Fund takes as a benchmark of financial crisis.5
The U.S. economy has ceased generating any net new jobs in internationally traded sectors, in either manufacturing or services.6 The comforting myth persists that America is shifting from low-tech to high-tech employment, but we are not. We are losing jobs in both and shifting to nontradable services—which are mostly low value-added, and thus ill-paid, jobs. According to the Commerce Department, all our net new jobs are in categories such as security guards, waitresses, and the like.
The vaunted New Economy has not contributed a single net new job to America in this century. Not one.7
The mysteries of international finance that let America run a seemingly infinite overdraft against the rest of the world looks suspicious, too—because that’s what it means to endlessly import more than we export. But where does the money come from, at the end of the day? Can we really get something for nothing forever? Or are we in for another crisis like the 2008 financial crisis? Subprime mortgages looked too good to be true, and then they blew up. The aftershocks are still hitting us. Is trade going to be the next shoe to drop?
Common sense seems to say that American workers are going to have problems when we trade with nations, such as China and India, where the average wage is a dollar an hour or less (57¢ an hour for Chinese manufacturing workers, to be exact).8 Corporate America even admits, with barely concealed glee, that competition from foreign labor has American workers pinned. As one Goodyear vice-president put it, “Until we get real wage levels down much closer to those of the Brazils and Koreas, we cannot pass along productivity gains to wages and still be competitive.”9
Brazils? Koreas? Our wages?
These nations and others are booming as exporters to the United States. But they remain far too poor to take back enough of our exports to balance our trade. Their combination of dreadful wages and regulatory standards on the one hand, and winning economic strategies on the other, has so far produced nothing like the living standards needed to
make them significant importers of American goods. Despite recent decades of economic growth, there are still over a billion people in Asia earning less than $2 a day.10
Working conditions are the flip side of low pay in developing countries. Production methods long ago abandoned in the developed world—many of them dangerous and environmentally unsound—are still widely in use. In India, for example, foundry workers often don’t wear socks, shoes, protective headgear, ear plugs, or even eye protection. Often wearing no more than boxer shorts, they squat on the floor next to the roaring furnaces.11 Charles Dickens has moved to Asia.
The environment is threatened. Thousands of foundries in China run on industrial-grade coke with no pollution control devices on their smokestacks, creating a plume of smoke that stretches across the Pacific on satellite photos. Chlorofluorocarbons (CFCs) are banned in the United States but still used in China as a blowing agent for the production of polyurethane foam cushions and the like, providing a significant cost advantage for Chinese manufacturers.12
None of this happens by accident. Foreign governments treat trade as war and use every trick in the book—legal and illegal under international agreements—to grab their industries a competitive advantage. And even when they don’t cheat, they are often more skilled in cultivating their industries than we are. Toyota, despite its troubles, somehow didn’t go bankrupt when GM did.
All these facts impinge upon America because of free trade. But economists keep telling us everything will be fine. According to them, free trade is good for us and they can prove it. Ninety-three percent of American economists surveyed support free trade.13 This inescapably raises the question of whether they have been doing their jobs—and whether America should stick with the policy they recommend.
