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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.
People with a more solid grounding in economics that I should take this up, but in the meantime:
how exactly is restricting trade going to help?
1st World economies are *export* economies. If an industry cannot survive at home, with the (admittedly far more limited) advantages of lower transport costs and dishonest ‘buy local’ campaigns, how is it going to produce anything worth exporting? While the USA might be able to maintain some purely local industries, the tiny OZ market cannot.
Horrible as the sweat shops are, they only survive because the alternatives are worse – or non-existent. Millions of people worldwide have been pulled out of poverty by free trade, are you really suggesting returning them to their previous squalor? Ethics aside, can we afford the destruction of those markets? And on the ethical side, our own blessings grew out of the grim situations of the 19thC etc; rather than opposing it outright, surely we should be determining whether 3rd world nations can walk the path our recent forebears trod? If not, then by all means cut those nations out of the loop, but not the ones that *can* pull themselves up.
I am happy to be corrected but it seems to me that because we no longer make T shirts or shoes we have more disposable income because they are made in 3rd world countries and are cheap.
The 3rd world countries get hard currency and my better half gets her shoe fix for next to nothing. Yes it sucks if you are in the business of making shoes, buggy whip makers had the same issue, market demands move and not all is down to trade deals.
Its hard on those caught up and many fall by the way side, but Friedman tells us that many more are advantaged by the shifts including me having sufficient money left over while the shoe and T shirt shopping is done to buy a coffee and cake whilst I wait ever so patiently.
I think your instinctive understanding of economics is pretty good. I have studied the subject perhaps a little bit more, so I can comment that it was the great British economist David Ricardo that laid down the principles of international free trade and why it works to improve both sides of the ledger. I think the drive to protectionism is largely a result of the fear of the unknown and an expression of a lack of confidence in Australian people. From my work in engineering on the international scene, I contend that Australians are as good as any and better than most.
Rob,
Just a little correction, those who lose their jobs or see a reduction in their wages, through less hours or lower hourly rates or abolition of penalty rates won’t have the money to buy the same number of tee shirts nor shop as often and certainly won’t be able to sit and have that coffee. (Your waiting time might in fact be shorter)
What do you see as the advantages for them from unfair free trade?
Keith,
Lower cost goods primarily increasing disposable income more “stuff” if you like helping this consumer society’s wheels turn. I think it is called creative destruction? No economist so can only rely on what I have seen.
Assets are released to be utilized in areas of higher return, individuals move to other industries, other jobs, nothing is stagnant.
I have been involved in the manufacturing game for 35 years and have watched this happen, the slow motion collapse bemoaned by so many. A sentiment my hip pocket agrees with. But once I get into my Japanese motor vehicle with every conceivable bell and whistle at a cost relative to the average wage considerably less than my first car I see the point.
My skilled engineers will start work on a LNG plant in Sachalin (Russian Island north of Japan) having completed specialist works in the plants here in AU, as the world shrinks our opportunities expand, 35 years ago they would have been restricted to a car manufacturing plant now they travel the world earning export dollars.
Of course there are those who cannot make the change, that’s why as a society we have safety nets isn’t it?
From what I have seen of my industry, stagnation is not the norm, the coffee shop worker on reduced pay starts their own because I have the time and the disposable income to buy their coffee, the soon to be unemployed power station worker in Victoria takes a job driving a bus and the production line worker at Holden starts picking fruit. I know each of these people personally, I have watched this happen since I was a wet behind the ears kid starting out, hell I did it myself when I started my first company called SBR, a name that I came to by taking the capitals from the root cause of the company creation……Started Because of Retrenchment.
A proposal in the article was what happens when these changes overwhelm us, from my admittedly limited view of what may be considered a strong example of such a collapse I haven’t see it. Do we like it…not particularly, I personally would have preferred to stay as we were in 2008 prior to the GFC but there is not much more to do other than roll up ones sleeves and get on with it.
I should also add that in a free economy it is my view there is no such thing as unfair free trade, just free trade. If you think it unfair to pay the lawnmower man a extra $10 to do your lawn you take your business elsewhere.
Its when roadblocks are put in that is the cause for trouble from what I have seen, stupid laws requiring thousands of licences to build a mine for example. Loonie greens and busybodies like Zenaphon limiting the areas of our relative advantage.
Rather than trying to keep noncompetitive industries I wonder if we are not better off making sure we actually play to our strengths,
Rob, I’vehada quick scan if your post and all i can say is no wonder people voted Trump and Brexit.
I doubt very much you’d understand why.
Then you would be wrong Keith. I understand very clearly why Brexit and Trump happened. I just don’t necessarily accept that the cause is change or the answer is protectionism.
Using SA as an example, automotive powerhouse dying from as late as 2004 when the mold making was shipped oversea’s, mining potential of Roxby Downs held up by the then Premier who in a fit of holier than thou green foolishness put paid to BHP turning that into the largest open cut in the world.
Had we have played to our strengths and stopped pouring millions into a noncompetitive car company and given BHP its head way back then SA would be a power house rather than a supplicant.
The best part was your ‘developed advantages’ which REFUTES everything you said about Ricardo’s ‘law’. You cannot have a law with exceptions!
Economics is largely rubbish, certainly not science. Ricardo, Malthus are just the opinion of London merchants in early 1800s. Adam Smith was against crown privilege, monopoly, royal prerogatives, rent collectors, feudalism, the East India Company and other royal monopolies. Smith is disrespected today he not just a free trader. He was a customs agent himself!
In the good old days, America was a LOW COST, HIGH WAGE economy from tariffs, dirigisme, etc. today it has become a HIGH COST, LOW WAGE ‘hollowed out’’ economy thanks to ‘free trade’. In which USA would YOU prefer to live? Yes, free trade brings cheap imports but also low wages, destroyed infrastructure and oligarchy.
The great tariff debates (beginning in the 1700s) are over. Hamilton, Clay, Carey WON because the USA (and China, and Japan and Germany and The Five Tigers), were built on protection. I doubt if anglo-sphere elites even worry about tariffs, the key is now: how you fund debt, fund the deficit, finance ‘development’. The mighty dollar is soon no more when the Chinese petro-gas-gold Yuan rises. The elites will try and destroy that.
For future reading cite the People’s Liberation Army’s most influential strategist, MAJOR-GENERAL QIAO LIANG who laid out his overall strategic philosophy at a book-study forum of the Communist Party’s Central Committee in Autumn 2015. His view can be taken to be that of the Chinese leadership.
Not surprising that economics is often called the “dismal science”. Someone once said flippantly that if all the world’s economists were laid end to end, they’d all point in different directions. May I offer the following amateurish contribution. The benefiting of third world countries to the hopefully modest detriment of first world countries could well be justified on various grounds, particularly if seen as a form of foreign aid. The problem is that in those poor countries, with very few exceptions, the lion’s share of all assistance received buys fleets of Rolls Royces, executive jets, palatial mansions and a lavish lifestyle for the rulers, so the country perpetually stagnates in its third world status. Ultimately, the disadvantage caused to first world countries by the process could well drag them down to the level of those benefiting from the “free trade”, so all could be equal in poverty. Wait a minute, isn’t that the aim of the progressive, socialist left?
Free Trade is where an individual (person or company) contracts with another individual to supply or purchase something. The question of the locations of the individuals is irrelevant. As an individual, I say to anyone wanting to prevent my trading affairs, either convince me not to do it or butt out.
Slavery ok?
slavery prevents the slave from determining how they will trade their labour, so clearly not OK under Brett’s statement.
Opium wars ok?
Brett
If you buy copies of my manufactured goods from someone else who is producing those goods and selling them at below the cost of production, because of slave labor costs, fake currency manipulations and ‘givernment’ subsidies, ignoring licences, copyrights and patents as well as corrupti practisesthen I and the employees who lose their jobs would feel entitled to punch you on you selfish smug little nose.
Why would you want your kids to earn wages that low? Better they go into industries where we have the relative advantage, earn high incomes and buy cheap goods and services ?
I have wondered, for decades, why Australian wages remain so high when he are actually competing – person for person – with low wage economies. Surely, I reasoned, our wages would decline concomitantly with those of our competitors for Australia to remain in the game.
Welcome to the world of free trade; your own standard of living declines as you attempt to compete. And unions blame others for what’s happening without being in the least bit capable of seeing the big picture. Or, at least, disingenuously attempting to have other Australian taxpayers make up for the shortfall.
Jody, I didn’t want to get back into this. My views are in the blog, but your point encouraged me.
The traditional argument is that First World (FW) countries have higher wages because productivity is higher than in Third World (FW) countries. OK. But a problem emerges when you take a complete FW business and move it holus-bolus to a TW country. Productivity of the business remains the same. Wages don’t rise because there is a glut of labour in the TW country. Profits of the business, of course, rise; and there is every incentive for businesses with high labour content to move. Workers in the FW country can then meditate on the benefits of free trade while waiting to sign up for the dole. Free trade in textbooks simply doesn’t cover this set of circumstances – and it was certainly never in Ricardo’s mind. Maybe a new economic theory is required.
Jody,
Will you take a cut in wages and now teach full time on half wages, so that you can be ‘competitive’?
America was a high wage low cost economy and did beat the low wage high cost ‘sweat shops’. Free trade is the slave owners economics, the issue caused the American civil war.
Teachers do not compete with third world countries; it is mainly manufacturing which does this. But unions have kept wages and conditions out of the real of reality. For example, sick leave, maternity leave, 9% superannuation, leave loadings and 4 weeks holidays as well as redundancy packages – none of these can hope to compete for a single minute with low-cost economies. They aren’t doing so and this is why jobs are leaving this country at a rate of knots.
Everything was ok in Australia in the 1945-early 1970s when unions were in fact strong.
In the period 1970s until now, a deliberate decision was made, by global elites, to de-industrialise Australia. With the end of McEwenism, Australia resorted to colonial status and being a big quarry
Our ‘ruling class’, the elites, the ‘internationalists’ of Bush’s New World Order etc, should also be also held to account.
That period of western prosperity had nothing whatsoever to do with unions and all to do with the fact that Europe and Asia were laid waste while Germany and Japan were busy losing the war. The ‘west’ was largely untouched by the war – the US particularly – and so became prosperous exporting everything needed to rebuild the axis countries and then service the demand created by those economies recovering.
Once those economies had recovered and become advanced enough they started making their own stuff and then started making our stuff better than we could.
Unions just benefitted from the prosperity they didn’t create it.
Equally it is not the ‘elites’ destroying Australia its simply more countries with the ability to compete on quality of goods.
While I don’t like the results and worry about a mass of long term un/underemployed low wage workers and the general race to be the bottom that globalisation is creating it is simply denying human nature to insist that CEOs DON’T make completely rational decisions to benefit their share holders and themselves. Thats just not how the world works.
There’s a simply way to remedy the imbalance; just stop buying imported goods, especially from low wage economies. But people want those cheap goods and they are part of the problem, not part of the solution. Notice the way Australians prefer imported cars to the local product any day of the week. Yet these people are probably one and the same complaining about business going offshore. Ergo, the ‘ruling class, elites and internationalists’ are supported by the people of each nation who can garner possession at half the price. In the case of cars, they’re far superior to the local product. Don’t blame the people who started the stampede because without the collaboration of the consumer it would never have gone past first base.
When Australia had tariffs, we had low unemployment, but there was a downside, in that there was a cosy arrangement between big business, big unions and big government, under which the unions could demand high wages and also impose restrictive work practices, which made our products uncompetitive. High tariffs, and collusion between management and unions, also meant that employers encountered problems when they wanted to innovate and raise productivity.
I seem to remember that in the 1980’s Quadrant campaigned against tariffs and the culture of what it called the Industrial Relations Club.
Last Monday, on Q & A, Tania Plibersek declared that the Liberals had destroyed our motor industry, she is incorrect, it was a combination of unrealistic wages and low productivity, plus the fact that the Australian consumer preferred Japanese or German built cars over the local product.
I do concede, however, that the theories put forward by the likes of Adam Smith and Ricardo were developed in an era when international trade was small. Britain did well from free trade, when it was the major source for manufactured goods, but I don’t know whether Smith and Ricardo ever envisaged an age when manufacturing would move to low wage nations.
‘Britain did well from free-trade’. Of course, that is why he had/have imperialism
This timely ‘discussion’ on Ricardo et. al. is vital to understanding todays events!
The only economists worth studying are economic historians of economic thought who can explain Smith, Ricardo, Marx, Lenin in history. These explain the neo-con and neo-liberal blueprint today.
SMITH theorised about ‘the absolute advantage’ of nations, and was against England owning colonies (too expensive). RICARDO argued about declining rents, declining fertility, comparative advantages of international specialisation. He believed imperialism was natural. The controlling mechanism for London was the gold standard.
MARX took up their arguments and then LENIN (from Hobson) developed his ideas about ‘imperialism the higher stage of capitalism’ and how capitalists seek profit outlets overseas.
Basically, this unholy group believed the imperial capital (London) would dominate. Would control money, would squeeze capital out of domestic (and international) labour, and fight colonial wars for resources.
TROTSKYITES (as a side comment, many worked/work in Washington for NED, and their spore is active today), lick their lips over these theories and believe it is coming true today. They also want to smash Russia (Stalin’s old home!)
So what is happening in the 2000s+?: never ending wars for resources (‘Pipelinestan’ in the middle east), companies seeking overseas profits, attacks on labor/survival of the fittest ideas, a coming war with Russia. The war on terrorism/Islam is part of the mix.
I think the three points in Peter’s second last paragraph are a pretty good summary which most thoughtful economists would agree with. The second and third points are usually glossed over as second-order adjustment issues that normally all wash out in a pattern of many adjustments to many small trade opportunities. But the evidence is that when you get vast shocks such as China entering the world economy (more as a result of its own reforms than trade agreements), the workers displaced from competing industries become first order adjustment problems. David Autor’s measurement of these issues in the US is very informative: http://www.econtalk.org/archives/2016/03/david_autor_on_1.html