President George H.W. Bush signed the North American Free Trade Agreement (NAFTA) in 1992. Did he take account of the probability that US manufacturing plants would move to Mexico? Did he consider the economic and social effects that this would have on many thousands of US manufacturing workers, their families and their communities? I doubt it. Elite indifference to the plight of ordinary (“deplorable”) people is precisely the reason why Donald Trump’s populism resonates.
Free trade is totemic for economic rationalists. It is unsurprising that they object to what they consider to be President Trump’s protectionist tendencies. The virtue of free trade is unarguable to its disciples. To them, those who have doubts clearly lack a proper understanding of the benefits it brings. The wellspring of our very progress and future prosperity is brought into question. To be clear, they have a point. No one should doubt the essential role that specialisation and international trade have played, and will continue to play, in creating wealth. That cannot legitimately be brought into question. However, what can legitimately be brought into question is the proposition that each instance of freeing up trade always brings net benefits to all participating countries.
A first thing to say is that “free trade” is usually a misnomer when applied to free-trade deals. Free-trade deals invariably run to many pages in length. NAFTA, which has earned Trump’s ire, runs to about 1000 pages. Clearly this is free trade with lots of ifs and buts. Ergo, a different NAFTA could be produced with different ifs and buts and could equally be called free trade. But this is incidental to my argument. My argument is that real free trade, or anything approaching it—freer trade—should be evaluated on a case-by-case basis. In particular, rich (First World) countries should be circumspect when striking deals with poor countries.
Free trade works best when it provides each participating country with comparable export opportunities or where it is built around participating countries having natural advantages. By “natural advantages”, I mean advantages springing from nature or from a long history of specialisation and skill development. Essentially, free trade flows should mirror the relative strengths of participating countries. All should gain. Any outcome that has one country benefiting to the detriment of another doesn’t necessarily sit well with the precepts of free trade.
History provides a backdrop. In 1817 David Ricardo set out his theory of comparative advantage. This theory is not innovative in showing that specialisation and trade are potentially beneficial. Adam Smith had already done that. It is innovative in showing that specialisation and trade are beneficial even between countries when one of them has an absolute advantage in producing all tradeable commodities. When, in other words, one country can produce all tradeable commodities more cheaply. It is a powerful testament to the benefits of free trade. It is instructive to examine the example devised by Ricardo to demonstrate his theory.
He used the example of England and Portugal and the production of wine and cloth. He configured his example so that it was beneficial for England to specialise in cloth and Portugal in wine; even though Portugal could produce both products more cheaply. Now, his example was made up; still, it would have seemed discordant if England had ended up with wine and Portugal cloth. That’s not quite right, we would think, example or not.
It was too cold in the Little Ice Age in England to grow grapes abundantly. At least that would be the common view. And the production of cloth fits our knowledge of the English inventions of machines like the spinning jenny (1764) and the power loom (1785). So Portugal had the climate and, I assume, the soil and home-grown expertise fitted for wine; while the Industrial Revolution fitted England for cloth. Of course, this is a potted account. Nonetheless it is good enough for my modest objective. My objective is to suggest that in Ricardo’s example specialisation and trade fell out of the natural advantages possessed by the countries in question.
Two additional factors should be borne in mind. First, both England and Portugal were First World countries for their time. Second, each country was insulated, relatively speaking, from the other. They were kept apart by distance and attendant transport costs, by culture and language, by slow communications, by imperfectly connected capital markets, and by labour immobility.
Jump 200 years to 2017. The world is interconnected. Internationally traded goods accounted for an estimated 2 per cent of all goods produced in 1817; now they account for about 45 per cent (World Bank merchandise trade data for 2015). Transport costs have become only a marginal impediment to global trade. Four years ago I took a twenty-seven-day voyage from Hong Kong to Southampton on board Magellan which, at the time, was the third-largest container ship in the world. It runs on cheap marine diesel and has a complement of a mere twenty-eight officers and crew. On my voyage it was carrying the equivalent of nearly 10,000 standard-sized containers. Each container, which can be more than double the length and taller than standard-sized, can hold up to 28 tonnes of cargo. Containers were off-loaded and on-loaded expeditiously at each port of call.
Why mention my voyage? Simply to illustrate starkly that times have changed. The cost of shipping machine parts, cars, whitegoods, computers and the like from one part of the world to another is now comparatively trivial in the scheme of things. And, to complete the contemporary narrative, English is a universal language, communications are effectively instantaneous, capital moves freely, and labour (as shown by economic migration flows) is mobile to a much higher degree than in the past; even than in the relatively recent pre-1960s past.
As I said in a previous Quadrant article (“The Debate That Never Dies,” July-August 2011), the modern world provides “fertile ground” for specialisation and trade to play out. To an extent trade has been based on natural advantages. Australia exports primary products. Switzerland exports watches. But by far the bulk of trade is not built around natural advantages but around developed advantages. It is a case of specialisation driving trade rather than the reverse; as recognised by Adam Smith.
Take two adjacent countries both equally adept at producing two different goods each of which is sold only locally. Nothing in the theory of comparative advantage (or absolute advantage) suggests that specialisation and trade will occur. There is no incentive. What will happen? Think of the development of the universe. Matter was almost evenly spread after the Big Bang. Almost is the key word. The slight unevenness allowed gravity to work to bring particular pieces of matter together. In turn, these supplemented pieces attracted yet more matter and the rest is history and eventually us. Equally, only a small perturbation may be required to disrupt the balance of production in the two countries. Once disrupted it is entirely possible that economies of scale will underscore the specialisation of each country in one or other of the goods. The production of both goods will increase and, through trade, both countries will benefit. Which good each country will specialise in is a matter of chance, in the sense that it is not predicable on the basis of natural advantages, which are the same in each country.
So far, so good. Whether trade is based on natural advantages or on developed advantages, there is a mutual and complementary benefit for both countries and, by extension, for numbers of countries involved in such trade. There will often be dislocation costs as countries switch out of one production activity to another. But, on the whole, there are evident benefits for all participating countries. And, on balance, there is no compelling reason to believe that the demand for labour will fall in any country after a period of adjustment. Consider a dissonant case.
Rexford is an American company. It has a ball-bearing manufacturing plant in Indianapolis. It has come under fire from Donald Trump for announcing its intention to move its plant to Mexico. According to reports, the company says this will save US$30 million annually. It has 350 employees who, again reportedly, are in the process of training visiting Mexicans. Presumably their severance pay is dependent on their co-operation. This must be hard to swallow, but that is an aside.
In 2013 the US Bureau of Labor Statistics (BLS) published an international study of manufacturing compensation costs (wages plus on-costs). The hourly cost (to the nearest dollar) was $36 in the US in 2012 compared with $6 in Mexico. Simple arithmetic shows that paying employees $30 an hour less, assuming a ten-hour day, saves Rexford $27 million a year. It seems fairly clear that the saving the company anticipates is predominantly made up of labour costs.
Mexico does not have a natural advantage in the production of ball-bearings. Mexico and the US have not reached a mutually beneficial trade accommodation related to ball-bearings. Mexico’s increased specialisation in ball-bearing production is not instrumental to its ability to produce them more cheaply. Mexico’s ability to produce ball-bearings more cheaply, and a host of other manufactured goods, is because its wages are at Third World level. The same story can be told for China and India, whose hourly manufacturing labour compensation rates were around $2 in 2010, according to the BLS study.
High-minded conservatives and libertarians who extol the virtue of free trade without qualification ignore inconvenient facts on the ground. One of these facts is that people in the First World are thrown out of work when they are put in a position by “free trade” deals of competing with people whose wages reflect the backward circumstances of their country. Often those circumstances have been caused over many years by entrenched economic and political corruption. Those who have been part of the social fabric of corruption gain at the expense of those who have been part of a more enlightened culture.
In textbooks, free trade is not about a First World country agreeing to allow a Third World country to take over most of its manufacturing activities. It is about mutually beneficial accommodations. It is worth going again to Ricardo’s example. Now imagine that Portugal has an exceedingly large reservoir of underemployed labour scratching out a subsistence living and, furthermore, that cloth-makers in England are willing and able to switch their operations to Portugal. England will have to find another outlet for its labour while using its gold reserves to pay for wine and cloth imports. And, after finding and building a replacement manufacturing activity, who knows, that too might go to Portugal. Quite simply, one-sided free trade driven solely by cheap labour does not necessarily work to the advantage of both sides; at least not until the long run has worked itself out, when we might be all dead, as Keynes so ominously put it.
Suppose you run a workshop near the border. A competitor opens up across the street employing sweated labour. Foul! You cry. Now put this competing workshop just across the national border. Exactly why has the unfair competition become fair? Free trade deals are like any other deals. There must be a quid pro quo. Both sides need to reap tangible gains otherwise the deal is exploitative.
I will put the other side of the argument, using the United States as an exemplar of an industrialised First World country. The US gains from cheap manufactured imports from China and Mexico. These products would cost a lot more if they were made locally. This benefits US consumers and also businesses that use such products as inputs. In turn, these businesses become more competitive and might, as a result, expand and employ more people. Yes, there are dislocation costs but these are temporary while markets adjust. That’s the argument. There is no fault in its economic logic and undoubtedly the US has benefited from cheap manufactured imports. Why then have qualms? It is glib.
It describes an open-ended process, which assumes that net benefits will continue being reaped however much manufacturing switches out of the US. It fails to contemplate the likelihood of dislocation costs becoming overwhelming. As perhaps they have already in parts of the industrial heartland of the US. For some workers the adjustment process lasts longer than the remainder of their working lives. They are victims of free trade. How exactly do you quantify the costs of that? Certainly such costs should not be glossed over.
It might be sensible to put in place provisions to guard against a flight of manufacturing production when negotiating trade deals with countries whose labour costs are completely out of kilter with First World standards. Take the US and Mexico. Without trade impediments, the playing field is markedly skewed to favour a flight of labour-intensive US manufacturing businesses to Mexico. The advantage of cheap labour is complemented by having the world’s largest market for their products right on their doorstep. Hence for Donald Trump to threaten to impose a “border tax” in such circumstances, in an effort to balance the playing field, is probably impractical, but it is responding to a real problem.
There are three things to remember in the debate over free trade. First, free trade usually isn’t free trade at all. It is freer trade at best and comes in many variants. Second, while freer trade tends to expand total production of all goods, it doesn’t necessarily benefit each participating country to nearly the same extent. Third, freer trade can have unfortunate consequences for numbers of people, which can be difficult to measure and which, in consequence, are not given the consideration they warrant.
Trump’s stated view that free trade has to be fair trade should not be summarily dismissed. Nothing in the textbooks under international trade that I have seen has one country voluntarily worsening its position to benefit another. Essentially that would represent a betrayal of the precepts of free trade.
Peter Smith is a frequent contributor. He wrote the article “Scary Population Tales” in the December issue.