TCS Daily

Free Trade: A Consumer Revolution

By James K. Glassman - December 6, 2001 12:00 AM

Editor`s Note: The remarks were first presented at Hillsdale College in Michigan.

It's a pleasure to be here today at Hillsdale and thank you for inviting me. I speak on a lot of different topics and I'm going to talk to you tonight about trade.

It was Ronald Reagan who said that "economists are people who see something work in practice and wonder if it would work in theory." I think this is a wonderful quote. And what is working in practice -- or has been working for the last two decades -- has been the U.S. economy. We have just been through the longest period ever in American history of sustained growth. Even though we may have entered a recession in the first quarter of this year, we've broken all records for growth over the last ten years. And if it is a recession, it will probably be a very shallow one.

Adding to that, since 1982 we have had sustained growth with only one very shallow recession that lasted three quarters of a year. Unfortunately, it was deep enough for George Bush, the father, to lose his job. We've never had a period like this in American history. And when you look at the stock market, in August of 1982 the Dow Jones Industrial Average stood at 777. Today it is about 10,777. It's up by a factor of 13 in the last 18 years. Including reinvested dividends, which is something I recommend, now it is up by a factor of 20. If you invested $10,000 into the broad market in 1982, you would have $200,000 today.

Even though the economy is slowing down, a more interesting question is: "Why has the economy been so strong over the last ten years and the last two decades?" I think the answer really is a kind of a supply side revolution that began in the early '80s.

The Supply Side Revolution

Frequently people talk about supply side, where they are referring to tax cuts that were put in place during the early years of the Reagan Administration. Certainly those tax cuts did have a supply side effect. Until that point in the Reagan Administration, most economists concentrated more on the demand side than the supply side.

But I am not talking just about tax cuts, although tax cuts were certainly part of it. It was more about a revolution where more supply had to come on line. As a result, the business cycle has changed. How does the business cycle work? Pretty simple. There's prosperity, low unemployment, people begin to demand more goods, they have more money, they want to buy more things. The demand then bumps up against supply constraints, prices rise, which gives us inflation. The Federal Reserve then comes in, raises interest rates because they have to maintain the value of the dollar, the economy slows down, goes into recession, the whole cycle starts up again.

We have had nine recessions since the end of World War II and most of them, just about every single one of them, has worked that way. Over the last 18 years, we have only had one very shallow recession that didn't work that way. The reason is that during this period, as demand rose, it didn't bump up against the same kind of supply constraints. In fact more and more supply came on line and prices didn't rise. That is basically the same model we are dealing with today.

I mentioned tax cuts are one way to keep supply flowing because they encourage investment, and to some extent, encourage an increase in the labor supply. The Federal Reserve has done a much better job maintaining a stable currency; and it has done much better with monetary policy. Businesses are being run more efficiently where they are getting more output from the same amount of input.

The Role of Trade

And a major reason that supply has increased over this period has been free trade. There has been a constant flow of goods, along with people; immigration is a form of trade, which has added capital to our markets. While it started roughly after World War II, it has been accelerating in recent years.

Notice that I don't say trade creates markets for U.S. goods. It does, but that is not the point I want to convey. In recent years we have heard over and over again that freer trade creates jobs. The idea is that by lowering trade barriers to our goods, we can increase our exports to other countries. Those exports increase the overall sales and profits of American companies, which then go hire more workers. That equals jobs, jobs, jobs -- very simple. Trade does create jobs, on a net basis, not really more jobs overall. Instead it leads to more jobs in some sectors, but fewer jobs in other sectors. In the aggregate, this country trades good jobs, in general, for bad. Overall, trade creates wealth, which frankly is more important than jobs alone.

To further explain my point, let me relate an anecdote that was told to me by my friend, Jerry Jordan, who's the President of the Federal Reserve Bank of Cleveland. Jerry described an American businessman in China a few years ago, who came across a team of about 100 workers building a dam with shovels. The businessman commented to a local official that with an earth-moving machine, a single worker could build a dam that size in an afternoon. The official replied, "Yes, that's true, but think of all the unemployment that that would create." "Oh", said the businessman, "I thought you were building a dam. If it's jobs you want to create, why don't you take away the shovels and give them all spoons."

Work is what we need to do in order to acquire things that enable us to live well. Free trade helps us get those things more cheaply because it allows many more producers to sell to us, and because it frees us to concentrate on the work that we do best. That's the reason we trade with other countries.

Our Comparative Advantage

With the din over trade, NAFTA, WTO, Fast Track, and all the rest, the best arguments for trade have really not been heard. One argument is very powerful, and I think has been made cogently by economists for more than 200 years, but not so much by politicians. The other is a brief argument from principal, which I'll get to at the end. Neither of these arguments has a thing to do with jobs, jobs, jobs, nor exports, exports, exports. The argument for exports has just one positive; it seems to carry a lot of political punch at the local level.

Melvin Krauss at the Hoover Institution writes in his bookHow Nations Grow Rich, "free trade does not create jobs; instead it creates income for the community by reallocating jobs and capital from lower productivity to higher productivity sectors of the economy." In other words, trade allows us to concentrate on what we do best. It may kill jobs in the textile industry, which is labor intensive, but breed jobs in electronics, where ingenious Americans have a comparative advantage.

David Ricardo phrased the same in 1817. For example, a country is full of brilliant electronics engineers, but won't allow textile imports across its borders. The engineers would have to sew their own shirts. In turn, they would have less time for electronics and the country would be the poorer for it. The same would also be true if the electronic engineers were great both at electronics and at sewing, which is possible. What counts is their comparative advantage: what do they do better -- meaning more profitably -- than other people.

A famous example in economics involves the lawyer who is an excellent typist. In fact, he may be a better typist than his secretary. What makes the most sense for a sound economy? Should the lawyer split his or her valuable time between practicing law and typing? Or is it best for the lawyer to lawyer and for the typist -- who might not be very good at lawyering -- to type? Well, obviously, it is the latter.

That is the idea behind comparative advantage. I personally happen to be a very, very fast typist, but I don't think it's a great use of my time to type other people's papers -- although after this talk, in case you'd like me to do a little typing for you, I can do it, make a little extra change. The point is, it's not prudent for the economy for me to do that. It's not necessary to go into all elaborate economic discussions to understand why we trade. Why do we trade? We trade for imports. We don't trade for exports.

No one said it better than Adam Smith 200 years ago; in fact no one said many things better than Adam Smith 200 years ago. He said, "it is the maxim of every prudent master of a family never to make at home what it will cost him more to make than to buy." If a foreign country can supply us with a commodity cheaper than we ourselves can make it, we should buy it from them. That is why electronic engineers do not sew their own shirts. It is why most American families do not grow their own wheat or grind their own flour or bake their own bread. They have better things to do with their time, and it is exactly the same with foreign as with domestic trade.

Milton and Rose Friedman wrote years ago "a fallacy seldom contradicted is that exports are good and imports are bad." We cannot eat, wear, or enjoy the goods that we send abroad. We eat bananas from Central America, wear Italian shoes, drive German automobiles, and enjoy programs we see on our Japanese TV set. Our gain from foreign trade is what we import. Exports are the price we pay to get imports. Another way to say this is: we do not eat in order to work; we work in order to eat.

In exchange for imports, we offer other countries the things that we produce cheaper or better, computers, chickens, movies, power generators, or we just offer them dollars. In the words of my sainted former colleague, Herb Stein, they send us cars; we send them little pieces of paper. Not a bad deal.

Those little pieces of paper are in effect, non-interest bearing IOUs that the people who send us imports have to spend in this country. If they aren' t spent on goods then they are spent on investments, real estate, auto plants in Tennessee, or on Treasury bonds.

This is quite a deal. We benefit from the lower prices imports give us, and we can use the money we save to buy things made at home -- or better, we can invest it. It is this point where imports have immense benefits. They do a great deal to throttle inflation and U.S. businesses have been forced to become more productive. But the Clinton administration really failed to promote imports in their confused battle for Fast Track authority over the last few years.

We will see what happens with this administration. The Bush administration has a very experienced team on trade. Whether they will use the import argument -- which I think most Americans understand intuitively -- or not, remains to be seen. I'll tell you one thing, though; I am very pleased that President Bush is cutting back in his budget on export promotion programs such as the Export-Import Bank. These are institutions that promote exports and basically give money or provide subsidies to corporations to export. I think there are special breaks for corporations that we should not have, but also they are oriented in the wrong direction.

Consumer-Friendly Policies

Adam Smith wrote that consumption is the sole end and purpose of all production, in the interest of the producers who ought to be attended to, only in so far as it may be necessary for promoting that of the consumer. Ralph Nader and others who say that they're consumer advocates are actually producer advocates. They favor certain kinds of producers over other kinds of producers.

Ask this question: Does the policy help consumers? Free trade allows consumers to buy a cornucopia of higher quality goods from other countries at lower prices than they would pay if they were restricted to buying homemade goods. Trade is obviously a huge benefit for consumers, or individual buyers, and as Adam Smith says, what's good for consumers is good for the economy. Yet, consumer advocates like Nader want to stop consumers from enjoying the benefits of free trade. Why? To help others, to help producers -- or to help trade unions which basically represent cartel-ized producers.

It is indeed true that some producers are hurt by free trade and we can expect producers such as the textile industry and their employees and tomato growers and people like that to kick and scream over free trade. Well, that 's fine. But consumers, all 270 million of us in the United States, benefit mightily from free trade.

Taxation With Representation

And let me also direct some outrage at so-called liberal Democrats, people like Representative David Bonior of Michigan, or Nita Lowey of New York, and lots of others who oppose Fast Track -- that is to say, giving the President increased trade negotiating authority -- out of concern for "working" Americans.

Why do people like oppose Fast Track? I think it could be mere economic ignorance. More likely though it is to help preserve the interests of producers and unions to maintain their cartels, just as big business did in the Smoot-Hawley days of the 1920s and '30s.

We have come full circle. In 1928, it was Republicans who wanted high tariffs to protect their business supporters. Now it's the Democrats. It is an amazing change. The 1928 Democratic platform proposed to "increase the purchasing power of wages by reducing the monopolistic and extortionate tariff rates." That was a Democratic platform, and it was right.

Tariffs, or even non-tariff barriers, amount to a tax. Another word for tariff is tax. Tariffs raise the price of goods for consumers. Tariffs are, in fact, a discriminatory tax. They raise the price of a Japanese-made Toyota, but not the price of a U.S.-made Chevrolet. And as we know, the price of the U.S.-made Chevrolet will rise to meet, or maybe slightly undercut the price of the Toyota. That's the way it works. And who benefits? It is certainly not the consumer.

I believe that the arguments for imports are simple and powerful. In fact, I think that the argument carries a lot more political punch than most politicians understand. By some estimates, 13% of American jobs are export dependent. That's roughly 18 million American workers, or if you want to count their family members, 40 million Americans. But all 270 million of us benefit from imports. As an economic report of President Clinton correctly put it, imports of goods have kept inflation low while imports of capital have kept interest rates low helping to sustain rapid income growth.

I would also add a third kind of import, which has helped us, the import of labor. Labor also helped to keep prices low and technology humming. Jobs associated with goods exported tend to pay wages that are about 13-18% higher than other jobs. Exports are great, but the argument for them is much more narrow and unfortunately much more widespread than the argument for imports.

Free Trade and Human Rights

The second point that I would like to explain is that free trade is not merely an economic concept; it is a human right, a natural right. People should have the right to exchange the sweat of their brows, the product of their hands and their minds, with whomever they wish. I should be free to trade with my corner drycleaner, with a Balinese shirt maker, with a Cuban cigar roller -- yes even a Cuban cigar roller -- a Japanese laptop manufacturer. The right to trade is, I believe, one of our inalienable rights, along with life, liberty, and the pursuit of happiness that the Declaration of Independence talks about.

The government should only be able to stop trade between two people if that trade threatens the interests of national security, if we are at war or close to it. Unfortunately, the Constitution itself is at odds with this sentiment. It specifically allows Congress to lay and post excises -- that is to say tariffs -- and to regulate commerce with foreign nations. It is easy to understand that tariffs were far more important back in the 18th Century, when they were the main source of government revenue. But it is hard to deny that there is some natural or human rights interest in trade.

No More Tit for Tat

What does all this mean in a policy sense? My conclusion is that it would be smart for the United States to abandon its current negotiating posture, which is that we will take down our trade barriers, if you'll take down yours. This is a reciprocity based argument and it is built on a very faulty premise, which is that current protectionist measures are good for the United States, but we're willing to abandon them if other countries abandon theirs since we really want to get into their markets. This is like saying I will agree to stop banging my head against the wall, but only if you stop banging yours. The implication is that it makes sense for me to bang my head against the wall but I'm willing to negotiate away that asset as long as you stop banging yours.

Brink Lindsey of the Cato Institute wrote in 1991 in an article for Reason magazine, "the reciprocity-based free trade strategy helps to frame the whole free trade debate in terms that favor the protectionist lobby." This is a very important point. The special interests that seek a protectionist bailout rarely admit that they are out-competed by their foreign rivals; rather they claim that they are the victims of unfair competition.

"A policy of trade negotiations lends credence to this ploy by focusing attention on the other country's import barrier and 'unfair' practices," Lindsey said. And this is exactly right. If our aim is to get imports into the United States, then the best way to do that is to take down our barriers no matter what anybody else does.

Unilateral free trade should be the United States' policy. Forget negotiations. The Friedmans wrote, in 1980, we could assume a consistent and principled stance. Americans could say to the rest of the world: We believe in freedom and intend to practice it. We cannot force you to be free, but we can offer full cooperation on equal terms to all. Our market is open to you without tariffs or other restrictions. Sell here what you can and wish to, buy whatever you can and wish to, and that way cooperation among individuals can be worldwide and free.

Are unilateral free trade agreements still such a flaky idea? You hardly ever hear about it, but it isn't that flaky. A Professor of Economics at Columbia University points out that Hong Kong and Singapore are conspicuous unilateral free traders, as is New Zealand. Those countries have done exceptionally well economically. A large portion of the world's trade liberalization in the past quarter century has been unilateral, with beneficial effects to the countries that practice it. That Columbia professor writes, "The most potent force for the worldwide freeing of trade is unilateral U.S. action." If the U.S. continues to do away with tariffs and trade barriers, other countries will follow suit.

In general, nations would dismantle their obstacles to free trade only when they understand that it's in the best interest of their consumers. That makes sense. More and more, other nations are realizing that. By unilaterally adopting free trade, the U.S. can show them the way. With the demonstration effect, we will thrive. Taking down barriers has brought competition. It's made our auto industry better, our communications industry the best in the world, this demonstration effect is very powerful. Other nations will see the success of what we've done and they will rush to do it themselves. Besides, eliminating trade barriers is quite simply the right thing to do. 

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