The week before the election, I, along with a small group of other students from the University of Georgia, had the opportunity to get coffee and talk with Jim Barksdale, our state’s Democratic nominee for Senate. Barksdale is an unassuming, down-to-earth guy with a deep sense of civic responsibility. He’s a self-made businessman who runs an investment firm, and he genuinely seems to care about the people of Georgia and the issues they face. Fed up with “irresponsible and reckless policies from Washington,” he felt compelled to challenge incumbent Johnny Isakson for his seat this election cycle.
Among the topics discussed at the get-together: marijuana decriminalization and legalization, student loan debt, healthcare, foreign policy, and, of course, trade. Barksdale has been a crusader against what he calls “bad trade deals,” agreements like NAFTA, CAFTA, TPP, and TTIP that he claims are a major contributor to low wages and income inequality in the United States. Barksdale argued that these trade deals give large corporations an incentive to offshore because other less developed countries have weaker labor and environmental standards that make the cost of operation much cheaper, which increases unemployment and stalls economic growth. He also argued that domestic industries, like the auto industry, suffer greatly when faced with foreign competition.
While he ultimately lost to Isakson, Barksdale is not alone in his stance on trade. In a wave of populism, a number of politicians from both the left and the right, including our next president, have rejected new trade deals and railed against existing ones, either because they don’t provide enough protections for labor, health, safety, or the environment, because they hurt domestic industry, or because they deepen the trade deficit. Much of this rhetoric appeals to disaffected groups in the population, like laid off factory workers and working class employees with low wages, but it fundamentally misses the boat.
As Sam discussed in great depth in a previous post, free trade between states is almost universally beneficial. Comparative advantage, the idea that some states are comparatively better at producing a good or service than others, allows states to specialize in what they produce most efficiently and import from other states what they do not. Suppose one country, Country A, can produce either 30 bananas or 15 coconuts per day and another, Country B, can produce either 30 coconuts or 15 bananas per day. Both countries on their own could produce 10 bananas and 10 coconuts, but that wouldn’t be an efficient use of their finite resources. Instead, Country A could focus all its resources on producing 30 bananas while Country B would focus its resources on producing 30 coconuts, each opting to trade 15 units of their good for 15 units of the other’s. The result: more bananas and coconuts for everyone.
The above example—also known as the Ricardian model of international trade—vastly oversimplifies the complexities of the international political economy, as there are almost two-hundred countries, countless goods and services to be produced, and multiple factors of production to consider. Additionally, states generally look to diversify and avoid dependence on a single “cash crop” since that would risk Dutch Disease, an over-reliance on one industry to the point that other industries suffer (the term comes from Dutch tulip mania in the seventeenth century; for modern day examples, think Australia and coal or Saudi Arabia and oil). But the general idea still stands: states are better off when they specialize and trade than when they strive for autarky.
To be sure, some parties do have legitimate grievances. For workers laid off following Carrier’s move from Indiana to Monterrey, Mexico, trade deals are likely the cause of their unemployment; after all, Mexico has a comparative advantage in lower-skilled labor that firms like Carrier can exploit due to lack of trade barriers. But the answer isn’t to eliminate all existing and future trade deals. Indeed, certain policy solutions—e.g. the Trade Adjustment Assistance (TAA) program—could help to fix many of the negative externalities associated with free trade, as Sam explains:
Of course, low-skilled labor is an important part of our workforce, and it shouldn’t be ignored. It’s easy for college students like me to talk in the abstract about the benefits of free trade, but it’s another thing entirely for people living paycheck to paycheck. I understand this completely, and it is something that needs to be addressed. However, the solution is not to eliminate free trade. We should not hurt our national economic competitiveness simply to appease low-skilled workers. We should, however, invest in education and trade adjustment programs that teach workers new skills if they work in industries adversely affected by trade. This helps everyone. It allows workers to gain new skills and thus become more competitive on the market, and it also increases America’s human capital, thus boosting our overall GDP.
However, rather than propose those policy solutions or any coherent alternative whatsoever, the anti-trade coalition prefers to throw the baby out with the bathwater and scrap the system altogether. The reality is that no viable alternative exists to free trade. In fact, the only alternative to free trade is protectionism, which is extremely inefficient, expensive, potentially dangerous, and exacerbates the very problems that populists blame on trade.
First of all, protectionism raises the cost of living. Think of all the goods in your daily life that were produced in other countries: most of your clothes were probably made in China, your car might have been made in Japan or Germany, the fruit in your refrigerator probably came from Central America, and your cell phone was manufactured with parts from several different countries. These goods were produced outside the U.S. either because American firms took advantage of cheaper factors of production overseas or because foreign firms in other countries possessed a comparative advantage over American firms in that area of the market, resulting in a cheaper final product for consumers. Protectionism would significantly impede both foreign producers’ ability to access American markets through tariffs, regulations, import quotas, and domestic subsidies, and American firms’ ability to take advantage of cost-cutting opportunities in other countries, ultimately raising costs for consumers.
Proponents of protectionism argue that such restrictions on trade are necessary to grow the market share of domestic producers by making foreign goods more expensive. Empirically, this logic fails; import quotas intended to protect the auto and steel industries a few decades ago failed at increasing the market share for domestic producers and only made those goods more expensive, costing the economy billions of dollars. Likewise, subsidies to the sugar industry pass on billions of dollars of costs to consumers at the grocery store each year because tariffs artificially inflate domestic sugar prices.
Protectionism also stifles competition and results in fewer choices for consumers at a higher cost. At the microeconomic level, competition refers to the rivalry between producers to secure the business of a consumer by offering the most favorable terms—e.g. lower costs or better products. Increased competition forces producers to differentiate themselves from one another to appear more attractive to consumers, encouraging innovation, higher quality products, and lower prices. Inversely, lack of competition removes the incentive to innovate or cut costs because a producer’s market share won’t be threatened by other producers, regardless of how dissatisfied consumers become. Foreign competition in American markets pressures domestic companies to do more to secure the business of American consumers, encouraging them to produce more attractive products in order to adequately compete, giving consumers better choices. Protectionism would create hurdles for foreign producers to enter into the American market, weakening the incentive for domestic companies to produce better goods because they wouldn’t face significant challenges to their market shares from the outside.
While populists love to rail against free trade, there exists a very strong populist case against protectionism, too. Trade barriers are an example of rent-seeking, and protectionism functions as a form of corporate welfare that benefits big businesses by reducing competition. If those businesses can corner the market, they can sell goods at artificially higher prices, ultimately hurting consumers. It also places a disproportionate burden on smaller businesses that rely on low-priced imports to compete, driving away jobs and investment and placing a major drag on the economy.
At the international level, protectionism leads to reciprocal restrictions on trade by other countries that have a profound negative impact on American businesses. If the U.S. were to introduce massive tariffs to protect its corporations from competition and its workers from offshoring, countries like China and Mexico, two of our largest trading partners, would be inclined to do the same, prompting massive trade wars that would devastate the global economy. From a growth standpoint, the inability to access foreign markets stymies economic expansion. With only 320 million people, the U.S. makes up less than 5 percent of the world’s population. That means 95 percent of the world’s consumers lie outside of the country. If companies can’t compete in foreign markets, trillions of dollars in potential revenue get lost and don’t get cycled back into the U.S. Moreover, American companies that rely on consumers abroad for revenue would suffer greatly, and companies that rely on cheap labor overseas to produce cheaper goods could no longer do so and would pass off new costs to consumers.
The historical precedent exists for snowballing protectionist legislation prolonging global economic downturns. In 1930, to combat the effects of the Great Depression and protect American businesses, Congress passed the Smoot-Hawley Tariff Act, which raised tariffs on tens of thousands of goods to record levels. In response, trading partners introduced retaliatory tariffs, resulting in the reduction of American exports and imports by more than half and deepening the impact of the Depression.
The consequences for foreign policy might be even more dangerous, and protectionists tend to ignore the strategic reasons for why the U.S. has been such a proponent of free trade in the past. Free trade links economies together and makes them interdependent, raising the cost of conflict between states because war would eliminate a potential trading partner. It also undergirds “democratic enlargement,” the econocentric foreign policy championed by the Clinton administration, which sought the integration of transitioning states into the global economy to make the international order more prosperous and secure. Democratic enlargement holds that trade liberalization promotes the development of a consumer-oriented middle class in nascent democracies, engendering stability and allowing for democratic institutions to flourish within these states. Together, interdependence through trade liberalization, shared political cultures brought about by the spread of democracy, and integration into international institutions mutually reinforce one another and reduce the risk of conflict. This feedback loop, also known as the Kantian peace triangle, helps convert the vicious circle of fear, mistrust, and conflict associated with the security dilemma into a virtuous circle that instills perpetual peace.
Protectionism would undo much of the progress that has been made over the past 70 years in the international system toward achieving that perpetual peace. Trade barriers would undermine interdependence and lower the cost of war because states would no longer require each other’s existence for economic growth. Unable to amass gains through trade and cooperation, states would have an incentive to use force instead. This especially applies to situations where states with disproportionately large resource endowments can corner the market; vulnerable states might feel pressured into using force to secure access to those resources. For example, if a trade war were to erupt with China, rare earth metals, which play a critical role in electronics and military capabilities, would become artificially scarce because China, which controls more than 90 percent of the market, might curb access. Because the U.S. relies on rare earth metals for national security purposes, it may feel inclined to resort to aggressive behavior to ensure a stable and secure flow of those metals. That could push China and the U.S. to the brink of a nasty militarized dispute.
A favorite argument against free trade among protectionists like Donald Trump stems from the trade deficit, a negative trade balance that occurs when the United States imports more than it exports. Trump claims that we’re being ripped off by horrible trade deals that produce hundreds of billions of dollars-worth in trade deficits to China and Mexico. In actuality, the mercantilist fear of trade deficits is largely unjustified. The money used by Americans to buy imports is either used by foreigners to buy American exports or reinvested in the U.S. economy. When Americans spend more money on imports, more money gets cycled back in the form of investment in American assets. Growing trade deficits can also signal economic growth relative to other states because foreign entities invest more money into the deficit country’s economy, enabling consumers to purchase more imports. The trade deficit tends to grow during periods of economic expansion and shrink during periods of economic contraction, as proven by the small trade surplus during the recession in the early 1990’s.
In conclusion, protectionism is a poor economic strategy. It’s expensive for consumers and economies, inefficient at allocating resources, and dangerous for foreign policy. As Peter Sutherland, Founding Director General of the World Trade Organization, once said:
It is high time that governments made clear to consumers just how much they pay—in the shops and as taxpayers—for decisions to protect domestic industries from import competition. Virtually all protection means higher prices. And someone has to pay; either the consumer or, in the case of intermediate goods, another producer. The result is a drop in real income and an inability to buy other products and services.
With protectionist-in-chief Donald Trump set to take power in January, trade as we know it may drastically change, and the next few years could prove turbulent for both the American and global economies.