The Cost of Free Trade

Any renaissance of American manufacturing must begin by fundamentally reversing our trade policies—both in general and in particular toward China. Over the past two decades, leading U.S. manufacturers, both the venerable (like General Electric) and the new (like Apple), have offshored millions of jobs—by one recent estimate, 2.9 million—to China to take advantage of the cheap labor, generous state subsidies, and low currency valuation that are linchpins of China’s mercantilist development strategy. Other factors, including increasingly automated production, have also taken a toll on America’s manufacturing workforce, but it’s the mass exodus of American production to China and, more recently, the rise of indigenous, state-subsidized Chinese production that have decimated American industry and reduced the incomes of American workers.

The United States government did not have to stand idly by while the nation’s industrial base was disassembled. It could have preserved and promoted key industries and supply networks by creating favorable credit policies, tax incentives, local content rules, and tariffs to punish currency manipulation from countries like China. For that matter, the U.S. could have created more flexible trade rules when it helped to craft the World Trade Organization.

There was considerable support, particularly within the Democratic Party, for these kinds of policies—yet no such policy was ever put into place, for trade divides the Democrats more than any other issue. The division is peculiar: It splits Democratic presidents into two people, the candidate and the elected official.

In 2008, candidate Barack Obama, campaigning in Ohio, vowed: “I voted against CAFTA [the Central American Free Trade Agreement], never supported NAFTA [the North American Free Trade Agreement], and will not support NAFTA–style trade agreements in the future. While NAFTA gave broad rights to investors, it paid only lip service to the rights of labor and the importance of environmental protection.”

Now the Obama administration has won Congress’s support for trade deals with South Korea, Colombia, and Panama that are difficult to distinguish from CAFTA and NAFTA (though a provision in the Korean deal increases the number of American-assembled cars that can be sold there). In addition, the administration is hosting talks intended to promote a trans-Pacific partnership in trade with a variety of countries on both sides of the Pacific.

By reversing himself on trade, the president is following the example set by Bill Clinton. Clinton, too, sounded like a trade hawk in his 1992 campaign, in which he promised to crack down on unfair Japanese trade practices. By the end of his two terms, however, he was boasting of his record in passing NAFTA and legislation granting permanent normalized trade status to China.

In a January 2000 piece titled “Expanding Trade, Projecting Values: Why I’ll Fight to Make China’s Trade Status Permanent” that was published in The New Democrat, the newsletter of the Democratic Leadership Council, Clinton asserted that establishing normalized trade relations with China would boost American exports there and that increased trade would foster China’s democratization: “We want a prosperous China open to American exports; whose people have access to ideas and information; and that upholds the rule of law at home and plays by global rules of the road on everything from nuclear non--proliferation to human rights to trade. … It will open a growing market to American workers, farmers, and businesses. And more than any other step we can take right now, it will encourage China to choose reform, openness, and integration with the world.”

None of Clinton’s confident predictions have been borne out.

China remains a repressive authoritarian state engaged in dealings with abusive regimes around the world. In the first decade of the 21st century, the proportion of industrial production undertaken by state-controlled companies grew instead of shrinking. The flood of American exports to the China market never materialized. Instead, the flood of Chinese imports swelled. The U.S. trade deficit between 1976 and 2010 added up to more than $7 trillion; of that, more than 70 percent was accumulated after 2000. In 2006, just before the crash that began the Great Recession, the U.S. trade deficit had grown to 6 percent of U.S. gross domestic product (GDP). Between 1998 and 2008, the U.S. merchandise trade deficit with China alone rose 470 percent.

 

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The top five U.S. exports to China between 2005 and 2010 were oilseeds and grains (mainly soybeans), waste and scrap, semiconductors and other electronic components, aerospace and aircraft parts, and resin, synthetic rubber, and synthetic fibers. Two of these export sectors depend heavily on U.S. government support—Defense Department procurement, in the case of aircraft parts, and federal farm subsidies, in the case of agricultural exports.

While manufacturing as a share of employment declined in all nations with advanced industrial economies (OECD) countries from around a quarter in 1970 to an average of 16 percent in 2008, it declined least in countries with export trade surpluses like Germany (19 percent in 2008) and most in countries running large merchandise trade deficits like the U.S. (9.5 percent in 2008). 

 

If ever a policy has been discredited by its results, it is the American trade policy of Democratic presidents Obama and Clinton, which is indistinguishable from that of Republican presidents Ronald Reagan, George H.W. Bush, and George W. Bush. Yet every president asserts that the next feeble and unbalanced trade treaty or two will turn America into an export powerhouse of the kind that it has not been for the past 30 years.

What explains this disconnect between rhetoric and reality? Economic interest groups that have profited from the offshoring of industry to China—multinational corporations and their investors, importers and retailers like Wal-Mart—support the status quo. The Wall Street wing of the Democratic Party—personified by Clinton Treasury Secretary Robert Rubin and his protégé, Obama Treasury Secretary Timothy Geithner—has worked hard to ensure that Democratic presidents promote such trade deals, over the objections of the labor movement and many (at times, most) Democratic members of Congress. Meanwhile, the decline of American domestic manufacturing and its workforce has reduced the numbers and influence of the major constituencies for an alternative trade policy.

But there is more to America’s perverse and unsuccessful trade policy than interest-group pressure. The belief that greater liberalization of trade and investment must invariably benefit the American economy in the long run, no matter its short-term costs in terms of crippled industries and lost jobs, has become an article of faith for America’s bipartisan establishment for more than 50 years.

It was not always thus. Before World War II, the United States was one of the most protectionist nations in the world. University academic faculties generally reflect the interests of the businessmen who serve as regents, so it should come as no surprise that economics was taught differently in different parts of the United States in the 19th century. In the commodity-exporting South and the commercial Northeast, economists preached free trade. The center of protectionist economics was the newly industrializing Mid-Atlantic and Midwest, where the internationally famous economist Henry Carey was one of many who championed Kentucky Senator Henry Clay’s American System, which was inspired by Alexander Hamilton’s earlier support for federal promotion of infant industries. (Hamilton, it should be noted, preferred subsidies to tariffs.)

In 1881, in order to promote protectionism, a Philadelphia industrialist named Joseph Wharton founded the first business school in the U.S. Wharton viewed free trade as a “fungus … which healthy political organisms can hardly afford to tolerate.” In his deed of gift to the Wharton School of Finance and Economy at the University of Pennsylvania, the industrialist specified that the school should teach “how by craft in commerce one nation may take the substance of a rival and maintain for itself virtual monopoly of the most profitable and civilizing industries; how by suitable tariff legislation a nation may thwart such designs.” He made his gift conditional: “The right and duty of national self-protection must be firmly asserted and demonstrated.”

Unlike the Republicans, the party of manufacturing, the Democrats with their base among Southern and Western agrarians—eager to export their crops and to purchase manufactured goods at the lowest possible price—had usually favored free trade and low tariffs. But Republicans dominated national government from 1865 through 1932, promoting protectionist policies. By contrast, the one major Democratic president during this period, Woodrow Wilson, entertained a utopian vision of a global free market policed by a system of collective security. His congressional ally (and later Franklin Roosevelt’s secretary of state) Cordell Hull of Tennessee declared in his 1948 memoirs that he had long believed “unhampered trade dovetailed with peace.” Hull had reversed cause and effect: Military rivals do not engage in free trade, but that does not mean that free trade will end military rivalries.

 

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Twenty years later, campaigning for the presidency in the depths of the Depression and in a nation more industrialized than it had been in Wilson’s time, Franklin Roosevelt insisted that he supported protection for American industries where it was necessary. But Roosevelt fiercely attacked Herbert Hoover for his support of the 1930 Smoot-Hawley tariff legislation, and the accusation that Hoover wrecked the world economy by signing the tariff became part of Democratic partisan mythology.

Economists from Milton Friedman on the right to Paul Krugman on the left have dismissed the idea that the tariff significantly worsened the Depression in America or that foreign retaliation against the tariff caused global trade to collapse.   U.S. exports were no more than 7 percent of gross national product (GNP) in 1929. Between 1929 and 1931, U.S. exports fell by 1.5 percent of GNP, while U.S. GNP declined by ten times as much—by 15 percent. The volume of world trade shrank by two-thirds from the last quarter in 1929 to the first quarter in 1933. The global collapse in trade that came after the passage of the tariff was the result of a sudden, universal drop in demand, not of retaliation against American protectionism. A similar collapse in trade occurred in 2008–2009 at the beginning of the Great Recession, in the absence of tariff wars.

But the myth of Smoot-Hawley wouldn’t die. During his 1993 debate with Ross Perot about the pending NAFTA legislation, Vice President Al Gore handed Perot a framed picture of Senator Reed Smoot and Representative Willis Hawley, asserting that the tariff bill that bore their name “was one of the principal causes, many economists say the principal cause, of the Great Depression in this country and around the world.”

Gore was merely invoking what had become holy writ among America’s internationalist policy elites who had directed national policy ever since World War II and who lived in fear that the U.S. would revert to its prewar isolationism and protectionism. In the same way that “Munich”—British Prime Minister Neville Chamberlain’s agreement with Hitler in 1938—was invoked by the American foreign-policy establishment as a symbol of appeasement, so Smoot-Hawley became a symbol of the protectionist economic strategy that the now-hegemonic U.S. had repudiated.

The fear that actions taken to protect American industries from foreign competition, even in retaliation against unfair foreign practices, would lead to trade wars and global discord wasn’t the only pillar buttressing the cult of free trade. In 1934, the New Deal Congress passed the Reciprocal Trade Agreements Act, which transferred the right to set tariffs from Congress to the president as a way to guard against parochial trade policies. When the act was passed, no one anticipated that, in slightly more than a decade, the U.S. would be the dominant power in a war-ruined world and the leader of a four-decade struggle against the Soviet Union. Thanks to the Cold War, presidents began using their power as trade negotiators to give other countries access to American consumer markets in return for supporting American military or diplomatic policies.

As Alfred E. Eckes Jr. notes in Opening America’s Market: U.S. Foreign Trade Policy Since 1776, the limits on foreign aid imposed by American public opinion prompted American foreign-policy officials to opt for what Eckes calls a policy of “trade, not aid.” In the decades following World War II, the U.S. so dominated the global economy that policy-makers gave little if any thought to the prospect that free trade might ultimately undermine America’s manufacturing prowess. In an unpublished page for his memoirs, President Harry Truman wrote: “American labor can now produce so much more than low-priced foreign labor in a given day’s work that our workingmen need no longer fear, as they were justified in fearing in the past, the competition of foreign workers.” In December 1946, the State Department instructed its officials to help the countries in which they were stationed to export to the U.S.: “In general, a Foreign Service officer should give the same attention to serving United States importers as he would give to United States exporters.”

In 1953, a commission on trade headed by Daniel W. Bell, Roosevelt’s former budget director, proposed to increase imports of manufactured goods even if that led to unemployment for an estimated 60,000 to 90,000 American workers: “In cases where choice must be made between injury to the national interest and hardship to an industry, the industry [should] be helped to make adjustments by means other than excluding imports—such as through extension of unemployment insurance, assistance in retraining workers, diversification of production, and conversion to other lines.” President Dwight Eisenhower argued that measures “which tend to drive away an ally as dependable as Great Britain … do much more harm in the long run to our security than would be done by permitting a U.S. industry to suffer from British competition.”

Not content just to help Cold War allies prosper, the U.S. in the 1960s also sought to use access to the American market to drive development in the post-colonial world. In 1963, President John F. Kennedy called on the U.S. and its allies to open “our markets to the developing countries of Africa, Asia, and Latin America.” Kennedy warned an AFL-CIO convention in Miami that protection of U.S. industry risked “driving potential trading partners into the arms of the Soviets.” In March 1964, a Johnson administration task force on foreign economic policy, anticipating the rhetoric of 1990s New Democrats, called for a “war on poverty—worldwide. … The whole country would be the gainer if, over time, we could shift resources away from textiles, shoes and other unsophisticated manufactures into more advanced items where we have a comparative advantage … [such as] capital, scientific and technological research, skilled and educated labor.”

One of the few government officials who dissented from the prevailing orthodoxy was George Humphrey, Eisenhower’s secretary of the Treasury. A veteran of the mining industry, Humphrey declared at a 1954 cabinet meeting, according to another participant, “We were protectionists by history and had been living under a greatly lowered schedule of tariffs in a false sense of security because the world was not in competition. That has changed now, and the great wave of competition from plants we had built for other nations [is] going to bring vast unemployment to our country.” Humphrey’s cautions went totally unheeded, however.

 

Today, in challenging a powerful bipartisan consensus supported by Rooseveltian liberal internationalism and Reaganite conservatism and buttressed by academic dogma and historical mythology, progressive critics of the conventional wisdom about trade and investment have failed to speak with a single voice. Indeed, some progressive alternatives to free trade end up reinforcing the assumptions of the orthodoxy that they are meant to supplant.

It is tempting, for instance, for the center-left to invoke international economic competitiveness as a rationale for doing things that progressives want to do anyway, like investing in schools and infrastructure. But the unstated assumption behind the rhetoric of competitiveness is that countries like China are outdoing the U.S. in manufacturing because their educational system or their infrastructure is superior to that of the U.S. In reality, Chinese mercantilism, like that of Japan, South Korea, and other Asian mercantilist countries, is based chiefly on currency manipulation and state-directed credit to targeted export industries and infrastructure. As long as countries manipulate their currencies and subsidize their industries, no amount of investment in American education and infrastructure is likely to improve America’s trade balance and reignite American manufacturing.

A similar criticism can be made of progressives who confine their critique to calling for higher labor and environmental standards in our trading partners in order to “level the playing field.” Corporate decisions about offshoring have as much to do with state capitalist subsidies as they do with poorly paid workers. Germany and Japan, where wages are comparable to those in the U.S., continue to run chronic merchandise trade surpluses for reasons having nothing to do with low-wage workforces and everything to do with those nations’ strategic industrial policies and the structure and governance of their corporate and financial sectors.

The progressive case for rethinking America’s failed trade policies is weakened the most by those on the center-left who accept the premise that the U.S. must give up traditional industries to other countries and specialize in this or that “industry of the future.” These new industries are sometimes identified as “knowledge industries,” like product design and software writing, or with “green technologies,” like solar and wind power. But history shows that countries like the U.S. in the 19th century or China today may begin by manufacturing products invented elsewhere but soon develop their own native classes of inventors and entrepreneurs, along with native bankers to finance them. China is accelerating this process by compelling U.S. and European companies that hope to market their goods there to share their advanced, proprietary technology with their Chinese corporate counterparts.

Within the U.S., it would be absurd to create factories capable of manufacturing only renewable--energy products, instead of a broader range of manufactured items. Solar panels, for example, depend on the generalist industry of glass manufacturing. Finally, such new industries as renewable technologies are no more likely to remain in the U.S. than the old industries, confronted as they are by subsidized Chinese competition.

 

NOTHING LASTS FOREVER, and in time, the post-1945 American approach to trade will change. The driver of change may ultimately be strategic military and diplomatic retrenchment, as the American-dominated unipolar system gives way to a messier multipolar order. It may have made sense during the Cold War for the U.S. to have tolerated our allies’ mercantilism in order to keep them in the anti-Soviet alliance. But if, in the next few decades, China surpasses the U.S. as the largest economy, it would be absurd to argue that the world’s second-largest economy would have a moral duty to set an example of economic liberalism by unilaterally opening its market to subsidized exports from the world’s largest economy. By that time, emerging powers like India and Brazil as well as China may have begun rewriting the rules of world trade on their own. The result is unlikely to be a global economic order of which Cordell Hull would have approved.

In the meantime, proponents of action against foreign mercantilism and for an industrial policy that promotes American manufacturing might take heart from the statements and actions of some Democrats in Congress. Senators and representatives from the industrial states like Sherrod Brown of Ohio continue to champion the beleaguered manufacturing sector, while Senator Charles Schumer of New York speaks for many in Congress in threatening retaliation against Chinese currency manipulation. Congressional Democrats have set forth a “Make It in America” agenda including crackdowns on mercantilist trading practices abroad as well as advocating investments in infrastructure, energy, and education at home. The message appeals to Republican voters as well, to judge from the criticisms of Chinese mercantilism by Mitt Romney.

What is more, Congress enacted Buy American rules in the 2009 stimulus bill, despite a chorus of disapproval by the media and policy establishment. The Obama administration bailed out General Motors and Chrysler and, responding to a petition from the Steelworkers Union, imposed temporary tariffs on Chinese steel pipes and tires. This October, the Senate passed a bill enabling the president to impose tariffs on Chinese imports unless China allows the yuan to appreciate (though House Speaker John Boehner has made clear he’s disinclined to let it come to a vote in his chamber).

But similar temporary tariffs or quotas imposed by presidents from Reagan to George W. Bush have served only as an occasional counterpoint to the long-term process of offshoring productive industry from the United States. Washington has declined to develop anything resembling a national industrial and trade strategy, though such things are routine among most of the nations we trade with. The Great Recession and the ongoing erosion of domestic manufacturing may cause many to rethink the conventional wisdom about American trade policy—but there’s no guarantee this will actually happen.

Comments

Mr. Lind: I just read and was impressed with the depth of research you must
have done on the history of U.S. global trade.Your net assessment that we've
had a weak, ineffective one-sided free trade policy since the early 1970's is right on target. Along with the many mistakes, such as Bill Clinton's on NAFTA,you might have mentioned the most signifcant attempt at corrective actionto return to our basic practice of maintaining a balance or small surplus
in our trade with the rest of the world. That would be Warren Buffett's lead
article in Fortune Magaizine in November 2003. He said "Our trade deficits
are selling America out from under us. We've got to to stop it now, and here's how to do it! He went on to propose a balanced trade regimen in some detail.
Then in 2006, Democrat Senators Dorgan and Feingold authored Bill S.3899,
"The Balanced Trade Restoration Actof 2006". That proposed legislation was
ignored by the Bush Administration and hasn't been considered by Mr, Obama. The trade policy group with whom I work continues to make a
concerted effort to gain the necessary action in the face of another year
of a huge trade deficit of about $700 billion ,thousands of manufacturers
gone out of business and many thousands of good lost due a massive
flow of imports, plus off-shoring of U.S. production by American companies.
K.N. Davis, Jr. Former U.S. Ass't Secretary of Commerce.
Stamford, CT

Comparison of effect of free trade on US and Germany supports inference that it is not just about "cheaper labor" and you certainly make a compelling argument. US needs an emergency "IV drip" of new industrial trade strategies. Great article!

I agree that America must reform its industrial policy to make manufacturing strong again. For 30 years, I have worked with 100 U.S. firms to export American-made products and services to China and Asia. When I tell people what I do, they laugh. They can't believe that it is possible. The rise of China may wake America up from its mid-century dream that it rules the world. China was humbled a few times by other nations for exactly the same reason -- an exaggerated sense of self importance.

Its a right thing that Investing and trading successfully requires much more than luck, a hot stock tip or buying shares of a fund and forgetting about it.

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