Free Trade Doesn't Work

by Ian Fletcher

  It is narrowly true that if foreign productivity is as low as foreign wages—an easy claim to make with aggressively free-market theory and cherry-picked statistics—then low foreign wages won’t threaten American workers. But a problem emerges when low foreign wages are not balanced by low productivity. It is the combination of Third World wages with First World productivity, thanks largely to the ability of multinational corporations to spread their technology around, that has considerably weakened the traditional correlation of low wages with low productivity.186 For example, it takes an average of 3.3 man-hours to produce a ton of steel in the U.S. and 11.8 man-hours in China—a ratio of nearly four to one.187 But the wage gap between the U.S. and China is considerably more than that.188

  In any case, industrial productivity is not in itself a guarantee of high wages. U.S. manufacturing productivity actually doubled in the two decades from 1987 to 2008,189 but inflation-adjusted manufacturing wages rose only 11 percent.190 From roughly 1947 to 1973, productivity and wage growth were fairly closely coupled in the U.S., but since then, American workers have been running ever faster simply to stay in place.191 Wage-productivity decoupling has been even starker in some foreign countries: in Mexico, for example, productivity rose 40 percent from 1980 to 1994, but following the peso devaluation of 1994, real wages were down 40 percent.192

  WE CAN’T JUST COMPENSATE THE LOSERS

  It is sometimes argued that although free trade has some victims, its benefits exceed its costs, so it is possible for its winners to compensate its losers out of their gains, everyone thereby coming out ahead in the end. (This is the usual fallback position of mainstream economists once they admit that free trade has drawbacks.) It is sometimes even mischievously argued that if such compensation doesn’t happen, any problems are due to society’s failure to arrange it, and are therefore not the fault of free trade per se. In theory, this might be true (if the rest of free trade economics is valid), but it also means that a bureaucratic deus ex machina is required to make free trade work as even its supporters admit that it should. So free trade turns out to be laissez faire on life support from big government. In any case, such compensation rarely occurs, because free trade’s winners don’t have to pay off its losers. They pay off their congressmen instead—to vote for more trade agreements.

  Compensating free trade’s victims is the rationale for the U.S. Government’s Trade Adjustment Assistance (TAA) program, which has provided supplemental unemployment benefits, training subsidies, and relocation assistance since 1974. But this program is small, compared to the damage wrought by free trade: under a billion dollars a year. Few workers have actually used it, and the concept suffers from intrinsic problems. For a start, it is often impossible to identify who has lost a job due to free trade, as changing technology and consumer tastes also cost jobs (and legitimately). Furthermore, free trade does not necessarily work its harm by reducing the quantity of jobs: it can reduce their quality, their wages and benefits, instead. And when free trade drives down wages, it can do so industry-wide, region-wide, or even nationwide, so its actual victims are impossible to pinpoint. TAA has tended to function simply as supplemental unemployment insurance while people wait to get their old jobs back, not as a means of helping people transition to new jobs.193 This is its official purpose, based on the mistaken idea that the harm done by free trade consists entirely in transition costs.

  EDUCATION WON’T SAVE US

  One commonly suggested solution to America’s trade problems is better education. While this would obviously make America more competitive, that it would be enough is unlikely, if by “enough” we mean able to maintain wage levels in the face of foreign competition. For a start, our rivals are well aware of the value of education, so it can’t be a unique source of advantage for us. And unfortunately, the U.S. is simply no longer formidable from an educational point-of-view. Roughly the top third of our population enjoys the benefits of a world-class college and university system, plus other forms of training such as the military and the more serious trade schools. But the rest of our population is actually worse educated, on average, than their opposite numbers in major competing nations.

  Thanks mainly to the high school movement of the early 20th century, the U.S. once led the world in high school completion, the most readily comparable international measure of education. But we have been slipping behind for decades. This is clear from the fact that while we still lead among 55-to-64-year-olds (who were schooled over 40 years ago) we rank only 11th among 25-to-34-year-olds.194 (South Korea is first.) Not only is our college graduation rate of 34 percent behind 15 other nations, but it does not even reach the average for developed countries.195 Studies designed to measure specific skill sets tell an even direr story. According to the 2006 Program for International Student Assessment, American 15-year-olds were outmatched in math and science by students from 22 other nations.196 The very bottom of our population is more alarming still: one 2003 study reported that a third of the adults in Los Angeles County were functionally illiterate.197

  Furthermore, it is a testable hypothesis whether education on its own can protect wages, and the evidence is to the contrary. For one thing, a college degree is no longer the ticket it once was: workers between 25 and 34 with only a BA actually saw their real earnings drop 11 percent between 2000 and 2008.198 And, as David Howell of the New School for Social Research has written after looking at this problem on an industry basis, “Higher skills have simply not led to higher wages. In industry after industry, average educational attainment rose while wages fell.”199 This should be no surprise, as merely shoveling education into workers’ heads obviously will not save them, or the industries they work in, if these industries are bleeding market share and revenue due to imports. Neither can people be expected to devote time and money to acquiring more education (or be able to afford it) if there are no jobs for them at the end. Who feels like pursuing advanced training in automotive engineering today? The weak education of American workers is thus a self-reinforcing problem: educated workers not only support, but require strong industries.

  Looking to education as a magic bullet can also easily slide into a de facto plan to write off the uneducated and uneducable; some remarks by Rep. Marcy Kaptur (D-OH) make this point well:

  Putting money into research is this Holy Grail for people here who are all college educated when the majority of the country is not, and who put themselves on this elevated plane thinking they know. I remember [Clinton Labor Secretary] Robert Reich saying, ‘Here’s what America has to do, Marcy: see this salt shaker?’ ‘Yeah?’ ‘America’s going to do the design,’ he said. ‘It’ll be made elsewhere, but we’ll do the design.’ I thought, ‘Wouldn’t that be an answer from a professor?’ I want both! I want engineering and production because I know the people in my district who used to make goods but don’t anymore, and they have a right to make what they end up buying.200

  Not everyone is going to be able to get a master’s degree in nanotechnology.

  Superior technological prowess is unlikely to save America, anyway, for the simple reason that we increasingly no longer possess it. Despite our image of ourselves as a technology leader, we no longer rank all that high by a lot of key metrics. For example, the U.S. today is 15th among nations in per capita broadband Internet penetration—which will be a serious limitation on our developing the next generation of Internet applications.201 Our share of world patents is dropping fast,202 and federal funding for basic science is not keeping pace with rising costs, so it is declining in real terms.203 The entire annual budget of the National Science Foundation equals less than four days of our military spending.204

  Meanwhile, our competitors are very deliberately catching up. According to the Organization for Economic Cooperation and Development (OECD), the umbrella group for developed economies, China, with an economy less than a third the size of the U.S.,205 was number three in the world for spending on research and development by 2005.206 It is no accident that, ac
cording to the respected Georgia Tech Technology Index, China has now surpassed the U.S. in high tech competitiveness, and if the 27 nations of the European Union are counted as one, the EU has, too.207

  CREATIVITY AND FREEDOM WON’T SAVE US

  Another frequently suggested solution to our trade problems is superior creativity, based on the idea that the U.S. is an exceptionally creative society. America is often contrasted with China, and we are told that China’s political system prevents it from allowing its people sufficient freedom to be creative. This is a seductive idea because it flatters American values, everybody loves creativity, and creativity is a sufficiently vague concept that one can ascribe to it economic effects of any size one likes.

  Unfortunately, many of America’s serious competitors are simply not authoritarian societies in the first place. China, yes, but India? India is a democracy. So is Japan. So are our European competitors. So are many of the others.

  And while it might be nice to believe that freedom is a requirement for economic success, it is simply not observably true that authoritarian societies such as China are economically foundering.208 However disappointing to deeply held American values this fact may be, China’s authoritarianism has almost certainly helped its growth, by enabling factors like the suppressed consumption policy that gives it a 50 percent savings rate and correspondingly high investment levels.209 Censorship of the Internet isn’t strangling e-commerce there, even if it is hard to Google the Tiananmen massacre from a Chinese engineering school. Foreign businesses often like the crisp decision-making, obedient labor, and absence of democratic interference; computer chip maker Intel recently decided to build its new Asian plant in China, rather than India, for the latter reason. In the words of Intel’s chairman, Craig Barrett:

  India has the same issues as the United States. It is a democratic government. The decisions are slower to be made. You have to listen to all the constituencies. In China, they are much more direct... In China, it is a central planning form of capitalism...We were in serious discussion for chip manufacturing in India, but the government was a bit slow on semiconductor manufacturing proposals.210 (Emphasis added.)

  The results speak for themselves: India had a higher per capita GDP than China as recently as 1987, but today, China’s is over three times as high, and its lead is still growing.211

  Free trade isn’t going to democratize China either, a myth that has been promoted for decades to justify American trade concessions to that country. Beijing is well aware of the threat it faces and has a sophisticated and ruthless strategy combining ancient Confucian cynicism about human nature with the “global best practices” of modern authoritarianism.212 The commercial advantages of this regime are now filling the pockets of everyone in China with the wits to turn a profit, so this authoritarianism now has a huge constituency outside the government itself.

  Another version of the “freedom will save us” argument attacks cultural, rather than political, authoritarianism, usually taking Japan as its foil. Now compared to the U.S., Japan’s culture is indeed rather closed and insular. It may fairly be described as an ethnocentric, patriarchal, and conformist society, sometimes reminding observers of America in the 1950s. Yet its record of economic innovation has been strong. The Walkman was not created by some free spirit in a garage in Silicon Valley, but by Kozo Ohsone, manager of the tape recorder division at Sony.213 And innovations, such as commercially viable hybrid cars and flat panel TV, have continued to flow in the decades since then. Japan’s corporate conformists are today generating more high-tech initial public offerings than the U.S.214 So whatever perfectly valid reasons one might have for objecting to that kind of culture, lack of economic creativity is not one.215

  And if anyone wants to imagine an American advantage due to cultural diversity, Europe, with its 23 national languages and 2,500 years of high culture, has us beat hands down. (So does India, by that standard.)

  Even if we forget all the above and assume that America does have a fundamental advantage in creativity, most companies, most jobs, and most people are not creative. It’s easy to be dazzled by fascinating stories about entrepreneurs into forgetting that most people are not entrepreneurs. And most people won’t ever be, simply because one can’t have entrepreneurs without having a far larger number of people working for them. Even most jobs at genuinely creative companies like Apple Computer are not creative in any serious sense.

  POSTINDUSTRIALISM WON’T SAVE US

  Postindustrialism is sometimes suggested as a solution to our trade problems (or as a reason to believe they are not problems in the first place). Its most succinct formulation is this:

  Manufacturing is old hat and America is moving on to better things.

  The postindustrial economy is considerably less attractive today than it was only a few years ago, thanks largely to India’s success in computer software and business process offshoring. This discredited the rather odd idea that our competitors were only going to compete in manufacturing. But one still hears about postindustrialism now and then, and the idea played a large role during the 1980s and 1990s in getting Americans to accept deindustrialization. It has been promoted by writers as varied as futurist Alvin Toffler, capitalist romantic George Gilder, techno-libertarian Virginia Postrel, and futurist John Naisbitt.216 Newt Gingrich seized upon it as the supposed economic basis of his Republican Revolution of 1994.217

  Unfortunately, the core ideas of postindustrialism don’t stand up well to empirical evidence. Above all, a declining share of manufacturing in GDP is not an automatic correlate of economic progress. Between 1947 and 1966—a period of rapidly advancing technology and rising prosperity—manufacturing actually went up slightly as a share of our GDP.218 Manufacturing’s share of GDP has indeed fallen in recent years, with services expanding to fill the gap. But this merely reflects the fact that inflation has been lower in manufacturing than in services, due to higher productivity growth in manufacturing. (This is itself a clue that manufacturing might have its advantages!) If one adjusts for the inflation differential, manufacturing’s share has actually been quite stable for the last 30 years or so, and only began to decline around 2000.219 This is far too late for transition to a postindustrial economy to explain it, but entirely in line with our burgeoning trade deficit in manufactured goods. And if one looks at the trend not in America’s production of manufactured goods, but in our consumption, there is no decline at all.220 The gap between production and consumption is (as explained in the previous chapter) just our trade deficit. So using postindustrialism to justify our trade deficit in manufactures simply presupposes what it is trying to prove.

  Nevertheless, postindustrialism remains popular in some very important circles. In the 2006 words of the prestigious and quasi-official Council on Competitiveness, a group of American business, labor, academic and government leaders:

  Services are where the high value is today, not in manufacturing. Manufacturing stuff per se is relatively low value. That is why it is being done in China or Thailand. It’s the service functions of manufacturing that are where the high value is today, and that is what America can excel in.221

  Unfortunately, the above paragraph is simply not true, and manufacturing is not an obsolescent sector of the economy. Low grade “screwdriver plant” final assembly manufacturing is indeed primitive, and can increasingly be done anywhere in the world, making it an intrinsically low-wage activity. But the manufacturing of sophisticated high-tech products is a different matter and remains concentrated in advanced industrial nations. That “Made in China” stamped on the outer casing of fax machines, cellular phones, and other high-tech products often just means that final “kit” assembly took place there.222 The key internal components, which make up a large percentage of the finished product’s cost, are frequently still made in high-wage nations like Japan. In the case of fax machines, this is the electro-optical read-write head. In the case of printers, it is the print engine. In the case of watches, it is the movement.
Apple’s iPod, for example, is assembled in China, but its display module is made in Japan, its video processor chip in Taiwan or Singapore, its memory chip in South Korea, and its central processing unit in the U.S. or Taiwan—all nations whose average incomes are multiples of China’s.223

  Even more important than the value of these components is their value per man-hour of labor required to make them, as this is the ultimate basis of high wages. For example, of the 28,556 jobs created by the iPod outside retailing and distribution, 19,190 were production jobs, of which China captured the most (11,715). But 9,366 were professional jobs, of which high-wage Japan (with 1,140) and the U.S. (with 6,101) captured the lion’s share.224 For products whose production cost mainly consists of technology and capital, not low-skilled labor, low-wage nations have no advantage, as technology and capital are not cheaper there. The table below gives a breakdown of the cost structure of the average U.S. manufacturer:225

  Cost Structure

  Raw Materials

  45.98 %

  Labor

  21.00 %

  Advertising & Marketing

  9.00 %

  Research & Development

  8.50 %

  Interest

  3.44 %

  Transportation

  2.90 %

  Health & Safety

  1.60 %

  Energy

  1.53 %

  Environmental Protection

  1.48 %

  Land & Rent