Political Economy of Free Trade

Political Economy of Free Trade

Both western and emerging economies are moving towards increasingly free trade. Powerful nations and trading blocs are engaging in a seemingly neverending dialogue to lower tariffs and other trade barriers. The principle is to take advantage of comparative advantage. The problem with comparative advantage is that it removes the human equation. Companies that produce goods well can be undercut by companies that do not, but can do it more cheaply. The result is job loss, and this hits fully modernized economies the hardest.

The Institute for International Economics touts many benefits of free trade. The Institute has concluded that should existing trade agreements be concluded, the world economy will benefit from a reduction in trade barriers. One of the Institute's claims is that the American economy is 7.3% higher than it otherwise would have been, had it not been for participation in GATT and the WTO. The theory is that when trade barriers are eliminated, goods move more freely. As competition opens up, so does opportunity. The United States is full of educated, hard-working, innovative people. These people have easy access to cheap capital, and are protected by the strong rule of law. The result is that they are able to take advantage of the opportunities presented to them by free trade. Foreign markets are opened to American goods. Many foreign countries have a burgeoning middle class, which provides ample opportunity for these American companies to find growth in international markets. Without the trade agreements, the theory is that these companies would have been forced to compete solely on the domestic market. This would have restricted their growth opportunities, and consequently would have reduced net investment. By this rationale, the loosening of trade barriers has resulted in the 7.3% increase in the economy over what it would have without those barriers.

The Institute also postulated that if existing trade agreements were concluded, the American economy would see further benefit. This was estimated to be between $450 billion and $1.3 trillion per year. By that count, the wage of the average American would rise by $4,500 per year. These figures, of course, are averages. In terms of genuine impact, the gains would not be spread evenly. In that reality lies much of the criticism of these trade agreements. It is not the generation of wealth that free trade opponents decry, it is the inequitable spreading of the wealth.

What this means is that these overall economic benefits, the $4,500 increase in annual income for example, do not go to all Americans.

In fact, many Americans are adversely impacted by free trade. Free trade tends to affect industries wholesale. So while some industries reap significant benefits from free trade, others suffer greatly. The opening of Russia to a capitalist economy exemplifies this situation. In a protected economy, dilapidated factories with corrupt management could function, and even appear on paper to thrive. The opening of the economy revealed reality to these factories, and they were rendered immediately obsolete. The results were catastrophic to the Russian economy. But once the older generation started to die off, the younger generation that took their place was ready and able to handle the capitalist system.

Likewise, free trade brings those same realities to many sectors of the American economy. Some estimates show that as many as 228,000 jobs are lost every year due to America's participation in free trade agreements. These jobs move to countries with lower wage levels, lower environmental standards, and lower cost structures. Entire industries have disappeared from the American landscape. Some 2/3 of this 228,000 annual unemployed workers find new employment, but at wage levels significantly lower than they were receiving previously. Some estimates peg the new wages at 13-14% lower. Thus, the loss to the economy from the output of these workers, and their lower buying power as consumers, is estimated at $54 billion per year. Compared with the estimated net benefits, this seems like a small price to pay. Yet, it illustrates that the issue of free trade has a human element. People do lose their jobs, and many times they are unable to return to the standard of living they once enjoyed. The affects of this job loss can be devastating within certain regions. For example, when Wal-Mart dropped Rubbermaid for lower-cost suppliers in China, Rubbermaid was forced to close its flagship factory, resulting in 1000 lost jobs. Those jobs were lost from a town of only 24,000 people. Thus, when the removal of trade barriers allowed Wal-Mart to move to China, a country where people can live on their $100 per month paychecks, it paved the way for the entire economy Wooster, OH to be destroyed.

The economist would argue, however, that it is worth it to suffer such losses. Those losses allow for thousands of other companies to expand their operations, and for millions of shareholders to improve their wealth. As a result, the economy as a whole benefits. Job loss and hardship are an inevitable byproduct of economic change. Yet as human history has shown, nothing stays the same. Just as the powerful Incan Empire fell within days of the Spanish arrival in Peru, so too can industries fall just as quickly and painfully. The beauty of human beings is that, on the whole, we are a very adaptable species. There will always be those among us who are left behind, but conflict, strife and adaptation are essential to the strengthening of the species.

It would be easy for the international business manager to extol the virtues of adaptation, or of sacrifice for the greater good, to the masses of workers left behind as a result of the demolition of free trade barriers. However, it would be tough to justify to any given individual why they should be the one to sacrifice for the greater good of the nation. For younger workers, the advice is simple. If one industry does not work out for you, move on to another one. We live in a global economy, and our main strengths are education and innovation. Americans who are unprepared to exhibit these traits are essentially unwilling to take control of their own destinies. The unfortunate reality is that change can be cold to some. For younger workers, there is no excuse to be left behind by free trade. I would cite the case of Canadian wine makers. Nobody with a palate would have consumed Canadian wine before free trade. But when the first Canada-U.S. free trade agreement brought quality Californian wines to the market at the same price as domestic plonk, the Canadian wine industry adapted. It moved from competition on the basis of price to differentiation on the basis of quality. The industry, which was assumed to be finished as a result of free trade, is now stronger than ever. There is no reason why any younger worker should be left out of free trade's opportunities simply because one door has closed. For older workers, the situation is more dire. They have less opportunity to adapt, and are less apt to do so. I do not imagine I would have any words of hope. Some people are simply unwilling or unable to adapt and they will inevitably be left behind. It is a cold reality, but I would not sugarcoat it.