Towards a Better Free Trade

Equal Trade for Equal Partners


The North American Free Trade Agreement — NAFTA — ties Canada, the U.S. and Mexico together into a free trade zone. U.S. critics of NAFTA focus overwhelmingly on the downsides of trade with Mexico and say very little about Canada. This is not happenstance.

Donald Trump has gained much attention during the recent presidential campaign with his promises to renegotiate many of the international trade deals in which the U.S. participates. Establishment Republicans have tut-tutted his protectionist stance as bad for the economy (by which they really mean bad for the CEOs and private equity overlords who extract so many rents from our economy), and the Democratic establishment (you know, the same people who conspired to derail Bernie Sanders’ primary campaign in favor of the bought-and-paid-for Hillary Clinton) has done similar. Meanwhile, Donald’s message has resonated with wide swathes of the American public, who intuit that his plans hold out the possibility of making the average worker better off in a day-to-day sense, even if headline macroeconomic or stock-market figures look negative.

In this essay, I intend to explore a few key concepts in international trade theory, which will provide the background for me to set forth a basic rule of thumb which I think would enable a President Trump to make good on his campaign promises in a constructive fashion. To ruin the surprise a bit, my proposal boils down to: “freer trade between economically and socially similar countries, less free trade between less similar countries.” To coin a catch-phrase, I summarize this as “Equal Trade for Equal Partners.”

First, I should define what is meant by “free trade.” Many economists and legal scholars tie free trade into a larger complex of international freedoms, most famously embodied in the “four freedoms” of the European Union:

  1. Free movement of goods.
  2. Free movement of services.
  3. Free movement of capital.
  4. Free movement of people.

There are arguments of varying degrees of plausibility as to why it is good to link these four freedoms, and many proponents as well as critics have tended to assume that all of these inherently tend to travel together. But it will suffice for our purposes to note that these four points are logically and practically separable. This is an important point; a country could conceivably have free trade with a wide variety of partners but very selective immigration rules, negating the “free movement of people” principle. In fact, Singapore is a good example of a country that actually does this. Their economy is highly oriented towards international trade, and while they welcome in a good number of foreign workers, they are quite picky about who they let in and have no compunction about kicking out a foreigner once his visa is up. It is a failure of our public discourse that we cannot openly and honestly talk about the separation of these four points; say anything that questions the wisdom of free movement of people and you’re automatically a Racist — and out a job.

To put none-too-fine a point on it, then, free trade means, at the most basic level, the import and export of goods without tariffs or customs duties, and without the imposition of undue non-monetary burdens on the movement of goods. For instance, in the 1980s the Japanese would require that each car imported to their country undergo pointlessly rigorous and time-consuming safety inspections before it could be licensed for on-road use. Beyond the cash import duty, these technical barriers to trade were the measures which essentially walled-off that market from imported cars. Such a practice conflicts with free trade. In a rough sense, one can imagine partly-free trade as a circumstance in which tariff and technical barriers to trade exist between two countries, but their magnitude and impact are limited to some moderate, negotiated level. One can also imagine one-sided or lopsided circumstances — like U.S.-Japan car market in the 1980s — where one country finds itself with relatively free access to the market of another, but the second country does not have correspondingly free access to the first.

The second background point to understand is the classical theory of comparative advantage, first promulgated by David Ricardo in 1817. The potted version of this theory is that if countries vary in the efficiency with which they produce various goods, then everyone would be better off if each place specialized in its most efficient area of production and freely traded for the other required commodities, even if one country’s best area of production was not particularly efficient by global standards, rather than try to produce a little of everything itself to avoid all imports satisfy its own needs in isolation — this kind of attempted national self-sufficiency is a practice known as “autarky” and is pretty much the conceptual opposite of free trade. Ricardo’s theory is taken as an argument in favor of free trade, as any tariffs or frictions would discourage trade at the margins and encourage countries to spend more effort effort on producing within their less efficient areas. Now, this ancient and highly simplified theory is only marginally more accurate than phlogiston theory was in its day, but Ricardo is still taught as a valid conceptual starting point in economics classes, while chemists, in their introductory texts, have moved on to that 18th century invention we call “oxygen” and leave the discredited stuff for the mere historians of science to study. But people still think about trade this way, because there is some kernel of truth in there, which is the important thing to note.

The next background idea to consider is “new trade theory,” which is associated with Paul Krugman, of all people (yes, the same New York Times columnist who has published more than his share of liberal flapdoodle over the years). The potted version of this theory is that in advanced industrial economies an increasingly large share of production is in highly specialized goods for which there are substantial economies of scale and network effects. To use his example: These days, you don’t want to have a dozen companies building jumbo jets across a hundred different factories, because the overheads in design, testing, tooling and training would be ruinously overlapping. There is always a need to balance economies of scale against the need for robust competition, but the balance gets struck at different points for different kinds of products, and in some industries we accept a high degree of concentration. So we have Boeing and Airbus as the two main builders of widebody commercial jets worldwide, with major assembly facilities in Washington State and South Carolina for Boeing and, for Airbus, one in each of France, Germany, China and the U.S. Do you live in Canada, England, Switzerland, Italy or Japan and need a jumbo jet? You’re importing one.

But that’s fine, because each of those countries in turn hosts any number of their own high-value exporters shipping worldwide — Bombardier and petroleum, GSK and Rolls Royce, Nestle, Novartis and fancy watches, Fiat and the entire fashion industry, Toyota and Honda… the list goes on. In his archetypal example, Krugman observed that France and Germany are extremely similar in size, geography and human capital, so under the classical model you wouldn’t think that there is much comparative advantage between the two countries; you therefore wouldn’t think there’s much reason for the two to trade extensively with one another. Yet they trade with each other enormously, and the reason probably has a lot to do with returns to scale — it’s economically more efficient to have one giant measles vaccine factory in France and one giant polio vaccine factory in Germany and trade surplus vaccines with one another than to have two smaller vaccine factories in each country and be self-sufficient. And his final point is that the exact location of each scale-efficient industry doesn’t much matter with relatively free-flowing trade: There can be all sorts of historical reasons why we make all our movies in L.A. and all our jetliners in Seattle and all our tech startups in Silicon Valley — given that each of these industries benefits by clustering and each of these clusters can easily trade with the other clusters. This isn’t just idle theory: The L.A. region used to produce commercial jets but no longer does — McDonnell Douglas had a major factory in Long Beach for more than half a century, but when Boeing took them over it consolidated production in Washington State as being more efficient.

So the reasons for my rule of thumb start to emerge, but I should state very explicitly why I build it around a sliding scale. Specialization and economies of scale are all well and good, but its a bum deal for your “legacy Americans” when the specialization and network effects they’re competing against aren’t actually technical know how, economies of scale and innovative organization in a high-tech sector, which they can match by being equally innovative in another high-tech sector, but slave-like working conditions and a complete absence of environmental controls which drive down the costs of anything through sheer exploitation.

This is the crux of the matter. This sort of imbalance is why critics of NAFTA often complain about the effects of freer U.S.-Mexico trade, but say very little about freer U.S.-Canada trade: Mexican per-capita GDP is four to five TIMES lower than in the U.S., while Canada is barely 20% behind — which counts as nearly equal for these purposes. When Ford concentrates production of a certain engine in Windsor, Ontario, it really is likely because of the inherent efficiency of having the Essex plant concentrate on 5.0 liter V8 engines so another plant can specialize in something else, and not because Canadian workers will accept slave wages. At the same time, jobs in Windsor create additional prosperous unionized Canadian consumers who are very likely to buy a lot of American goods, supporting jobs on our side as well. But when Ford moves all its small car production to Mexico, we know they’re taking advantage of 5x cheaper workers who won’t support other American businesses the same way an equivalent number of Detroit — or even Windsor — workers would. And yet we let those cars right back into the U.S. with the same no-tax treatment that an American or Canadian built product would receive. Similarly, in the context of labor migration, the British in the run-up to Brexit complained loudly about Polish plumbers and Eastern European bricklayers and maids (and quietly — for fear of being tarred with the Racist brush — about Pakistani cabbies and short order cooks), but said much less about the French bankers, Italian chefs and Spanish architects who have settled in the U.K. under EU rules. This latter group is culturally more similar and economically more complementary than a flood of low-cost manual laborers, so they cause less dislocation.

Hence my prescription: Freer trade between similar countries; less free trade between dissimilar countries. The degree of restriction to impose on any given dissimilar country should be calculated in a way which accounts for the differences in human development, without overwhelming the natural comparative advantage that such country possesses. To understand this point, think of all our latte-swilling career girls for a moment: The people of North America, Western Europe and Japan drink an enormous amount of coffee — far more than can be efficiently grown in those places. We should naturally import plenty of coffee from Colombia, Brazil, Java and any other jungly place than can grow a good bean. But we shouldn’t import this coffee free of all restrictions. We should impose a tariff on each country designed to strip away the benefit of the low wage rates and lax environmental rules that prevail in such country, and impose whatever technical inspections are necessary in light of the (lack of) rigor of the home-country food safety regulations. But the warm climate and favorable mountain growing conditions will still make those countries the ideal low-cost producers even after tariffs and inspections. A relatively low employment level in the coffee farming sector in the U.S. is something we should live with at that point. There is no good case for resorting to homegrown Nazi-style Ersatzkaffe!

Such is the case for Equal Trade. The remainder of the “four freedoms,” and their interactions with one another, can be discussed some other time. But, no surprise, the rule of thumb will look quite similar in each case: Greater similarity and compatibility is a prerequisite for greater freedom.


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