Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

14 March 2016

Clear Thinking about “Free Trade”

For about three decades, conventional thinking about trade has relied on a spectacular non-sequitur. Not only is it false and illogical. It has produced an economic catastrophe for our nation. Now that our people and our pols have finally identified it, it’s undermining our politics as well. If its “discovery” makes Donald Trump president, it could produce a general, global catastrophe, perhaps even a military one.

The non-sequitur is simple to state but requires some explanation. In essence, it holds that selling a rich nation’s industrial infrastructure to poor nations is a necessary condition or consequence of “free trade.”

In order to see how absurd this notion is, we first have to recall what is “free trade.”

Since before World War II, the term “free trade” has been defined by its opposite: tariffs and other forms of trade protectionism whose purpose is to restrict trade and make markets a form of national property. An example was our own Smoot-Hawley tariffs, imposed before that war. Congress designed them to exclude Japanese manufactures from our American markets, and they were a key motivator for Japan’s aggression in World War II.

After that horrible war, leading powers recognized that market exclusion was not too different from territorial conquest. Territorial conquest says, “This land is mine!" Similarly, market exclusion says, “This market is mine!” Tariffs don’t have to be sky high in order to effect the exclusion. Imposed on imported products, a mere 10% cost increase, let alone a 25% one, is often enough to motivate domestic consumers to buy locally produced goods.

After World War II, leaders of major powers were fully conscious of the role of tariffs and other trade barriers in causing the war. Not wanting to repeat the awful experience, they convened international conferences and set about creating rules to lower and eventually eliminate the barriers. The process began formally with the General Agreement on Tariffs and Trade in 1947. It continued through the World Trade Organization’s formation in 1996. It continues today under such compacts as the TPP, or Trans-Pacific Partnership.

The general idea of all these agreements is that “free” trade is good, and artificial restraints on trade are bad. Today we have generally accepted economic theory to underline these points. Tariffs allow inefficient, high-cost domestic businesses to exclude goods made by better, more efficient firms abroad. They also force domestic consumers and businesses to waste money buying inefficiently produced (and therefor higher-priced) goods. At the same time, they make efficient foreign producers and their nations angry, just as our Smoot-Hawley tariffs did Japan before World War II.

So trade is good. Protecting inefficient domestic industries against better, more efficient foreign competition is bad. These points have become conventional wisdom in trade and economic circles over the last half-century. But do they justify, let alone require, a developed nation’s elite capitalists selling that nation’s industrial infrastructure to poor nations to lower prices and, in so doing, get rich quick?

This is the non-sequitur that both Bernie Sanders and Donald Trump have identified. It’s now a big issue in our Yankee presidential election.

Yes, it’s a good thing for commodities and manufactures to be sold, without tariffs, at nondiscriminatory prices that vary only by productive efficiency and transportation cost. That gives everyone, worldwide, an incentive to become the most efficient and lowest-cost producer and the most efficient user, who can pay the highest price.

But is it a good thing for rich countries like the US (and England earlier) to sell and transfer their plants and productive facilities—their entire industrial bases—to poor countries like India, China, Mexico and Vietnam? Does “free trade” require transferring rich nations’ capital bases to poor ones?

Ideologues often say that the hollowing of America’s industry and its sale to China, Mexico and Vietnam was a result of “free trade.” But that’s not how these things actually happened. China, Mexico and Vietnam didn’t build competitive plants with their own capital and technology. Rather, American capital, through so-called “direct foreign investment,” financed the plants in China, Mexico and Vietnam that undercut domestic plants’ prices. And American technology made those plants efficient. The capitalists got rich, and American workers lost their jobs. After a while, America lost a large fraction of its industrial base. That’s where we are now.

Maybe free trade permitted this self-imposed disaster. But to say that free trade required or caused it is to indulge in the fuzziest thinking possible.

American capitalists moved manufacturing offshore not to lower tariffs or reduce trade barriers, but to get rich quick. That they indeed did. They made huge profits, without regard to the consequences for American society and families. They did so under the rubric of “free trade,” deluding themselves (and the rest of us) that this scheme was all of a piece with dismantling the tariff barriers that had held back global prewar economic development and helped cause humanity’s worst war.

After three decades of this non-sequitur, the results of this process are pretty clear. The top layer of capitalists—the “one percenters”—benefitted. In our top-heavy capitalist system, they’re the ones who got paid for the transfer, or at least the lion’s share of payment. They have become the new oligarchs in our Second Guilded Age. The previously poor countries that received the transferred industrial bases also benefitted, as I noted in an essay published eleven years ago.

But the process also produced millions of real losers, as is now painfully apparent to voters here in America. American workers lost big. Millions lost their jobs. Most lost wages, or at least the increases in wages that, for most of our American history, had been considered American workers’ birthrights. Many also lost self-respect, for example, when they had to stop making cars or industrial equipment and to start flipping burgers at MacDonald’s or serving as “greeters” at Wal Mart.

Now it’s becoming increasingly apparent that the decreases in the domestic prices of goods manufactured abroad don’t compensate for these losses. Cheap Chinese products at Wal Mart don’t make up for the loss of a good job or for the resulting loss of a marriage and a secure family. Nor do they compensate for the increasing inability to afford a college education, at least without massive debt, which itself dims the prospects of future generations. In the aggregate, the loss of millions of good jobs has begun to slow economic growth. It has led to the stagnation and deflationary environment that most developed nations are now experiencing. It also harms workers’ and middle managers’ direct contract with manufacturing technology and customers—and therefore manufacturing progress and innovation—which having onshore productive facilities would have fostered.

In fact, our entire country took big hits. Since this process started in the United States, we have lost 60,000 factories to so-called “competition” overseas, mostly started by our very own executives and our own outsourcing. We have sold a large part of our entire industrial base for the profit of a few and the incidental benefit of foreign nations, some of which (like China) are now our rivals.

As anyone who’s ever served as a scientist or engineer knows, technology and technological knowledge build upon themselves. They are parts of a seamless web. As you lose substantial parts of that web, your ability to innovate and invent declines. And so you begin to lose your future.

And still we haven’t even mentioned another, related phenomenon: the transfer of corporate headquarters and corporate industrial bases abroad in order to reduce taxes. Not only has that transfer deprived the United States government of massive revenue. It has, to date, resulted in the “parking” of real money abroad, which does nothing but uselessly inflate corporate balance sheets and stock valuations. At the moment, estimates of the aggregate sum of money reach 2.5 trillion dollars. Just bringing that money home could, for example, make a huge dent in our vast and growing national infrastructure deficit.

All of this has little or nothing to do with “free trade” as such. Selling a whole nation’s industrial base to poor countries is hardly a necessary precondition or consequence of reducing tariffs and other trade barriers. Neither is withholding profits from taxation and repatriation. These things are separate and distinct phenomena, having more to do with the short-term greed of shareholders and their managers and the false god of “shareholder value” than any real support for “free trade.”

So how do we fix these blunders? Can we get our industrial base back? Can we recover the 60,000 factories that have “moved” offshore? Can we recover all the government revenue lost through tax “gaming”? Can we put the $2.5 trillion to work in our own country, if only for direct corporate investment at home?

The short answer to the first question is “probably not.” The 60,000 factories are gone for good. We certainly can’t bring them home with simple, crude market protectionism, such as re-imposing tariffs or other trade barriers. Nor should we. If we tried, we would upset the global economic applecart. We might even cause another catastrophic war.

As for the second and third questions, the answers depend on lawyers and pols and their determination to rebuild our nation. Corporate tax-reduction gymnastics and external bank accounts are legitimate targets of pols, but they won’t be easy to hit as long as Citizens United allows the rich to confuse the public and buy elections.

Yet not all is lost. The United States is still the world’s most innovative and creative nation. We may not be able to reverse the loss of factories for hand tools, furniture, kitchen implements, home appliances, and audiovisual gear, which have already fled to China. But we can prevent our factories for the next generation of great industries from moving to China, Mexico and Vietnam, or even to Bangladesh.

We can do that with legislation that imposes significant tax and economic penalties on capital that moves factories abroad. At very least, we can change our tax laws so that capital no longer has an incentive to move factories offshore and to park the profits from foreign operations abroad. We could and should make foreign operations of American companies pay their fair share of American taxes, and we could require or incentivize them to repatriate their foreign profits for use here at home. Nothing about doing that would require renewed tariffs or “protectionism.”

The most important thing of all is to do this for future industries. We don’t know now exactly what all of them will be, but we have some pretty good ideas. Among them will inevitably be: (1) electric cars, (2) high-capacity storage batteries (for smoothing the “intermittency” of wind and solar energy), (3) smart-grid technology for regionally smoothing and distributing locally-produced, sustainable electricity, (4) private space travel, and (5) emerging medical technologies, including synthetic organs for transplanting and personalized medicine.

In the medium term, a whole series of world-changing industries will likely evolve from the CRISPR-Cas9 gene-editing technology. As I’ve remarked previously, that technology is the most likely of all presently developmental technologies to become economically transformative in the same way that electric power, the automobile, aircraft and modern electronics and computers once were.

The Internet is a different story. Its software and services are intrinsically intangible. By their vary nature, they can fly around the world in milliseconds. In fact, notable Internet winners like Google and Facebook are already global companies. Trying to devise legislation to keep them here at home, or to put the genie back in the bottle, would be a fool’s errand.

Not only does their very nature circumvent any geographic restrictions on Internet companies. In general, Internet “industries” are not really “transformative” at all. Airbnb, for example, just replaces hotels, short-term rentals and time-shares. Uber replaces taxi drivers and limousine services. They’re just more efficient ways of doing and organizing the same old businesses. They may make a lot of quick fortunes; and they may have political effects even less foreseen that IS’ recruiting of suicide bombers among ostensibly satisfied, assimilated Yanks. But they won’t transform any economy the way cars, planes, electricity, radio and TV or computers once did.

However high their stocks’ price-to-earnings ratios may be, Internet firms are primarily means of disintermediation and communication. They are hardly productive “industries” with factories or other wealth-creating output of their own. And however much they otherwise change, they will never sell our nation’s industrial infrastructure abroad as our 1% has done over the past three decades.

So let’s not worry about software and Internet companies. What we must do is create rules that keep the next generation of research-and-development laboratories and real productive factories onshore. These rules can reinforce and supplement the natural incentives of being closer to customers and local resources, closer to the world’s best higher educational system, and closer to the rest of the seamless web of advanced technology that feeds on itself in producing real innovation.

If we wait too long to re-spin that web in the United States, it may move abroad forever. Then our secular decline may become irreversible.

Doing all this will not require tariffs, so-called “protectionism” or violating the last century’s salubrious rules of free trade. What it will require is some careful thought about how to preserve and expand what still makes our nation the world’s most innovative and creative society, and how to project that “what” reliably into the Third Millennium.

What we need is a common-sense effort to maintain and expand our society’s and culture’s comparative advantages by reducing the short-term, short-sighted self-enrichment of our owner class, our 1%. Surely successors to the thinkers who created world’s freest, richest and most advanced society can handle the lesser task of protecting its medium-term survival and prosperity against the self-interest of those who just want to get rich quick.

Footnote (added): A friend suggested that I name specifically the well-known reasons why foreign plants set up by American capitalists could undercut their American counterparts and put us Yanks out of work. They are, in rough order of importance: (1) much lower workers’ wages in poor countries, (2) more relaxed environmental and other regulatory requirements there, and (3) less stringent protection of labor.



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