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Thursday, April 09, 2015 3:00 AM

Readers Question Free Trade; Does Nonreciprocal Free Trade Cost Jobs? Paul Krugman "Was" Right!

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I received many questions and comments regarding Obama's Trans-Pacific Partnership Fiasco vs. Mish's Proposed Free Trade Alternative.

While most do see Obama's Trans-Pacific Partnership (TPP) as a fiasco, many question my alternative proposal:

An excellent free trade agreement would consist of precisely one line of text: All tariffs and all government subsidies on all goods and services will be eliminated effective June 1, 2015".

Even some "free trade" advocates disagree with my follow-up statement "I firmly believe the first country that fully embraces free trade would come out ahead, regardless of whether or not any other country reciprocates."

Worry Over Loss of Manufacturing Jobs

Reader Pina is worried over the loss of jobs. He writes ...

I realize that most economists advocate tariff free trade but how is this in the interests of workers who had careers in the rust belt who have watched their jobs migrate to China, India and other countries. Yes, American multinational corporations like the cheap labor and modest regulation in the third world but is this really best for the American worker?
Seen and Unseen

For starters, employment in manufacturing and some service industries is down everywhere due to hardware and software robotics. Tariffs or not, many manufacturing jobs have vanished and are never coming back.

Initially, those jobs left the US because of wage differentials, now they are simply gone.

Moreover, and more importantly, it is a mistake to look at manufacturing (or any trade) in a vacuum. We lost manufacturing jobs, but cheap goods from China provided millions of trucking and shipping jobs and allowed the expansion of massive numbers of retail jobs and construction jobs to build all the stores and malls everywhere.

Standards of living have soared. Even the poorest of families tend to have cell phones, internet services, and huge digital TVs.

Were the price of goods to double to save manufacturing jobs how many could afford to buy such things?

Productivity and Free Trade

The Library of Economics and Free Trade has an excellent article on the subject. It's title is simply Free Trade.

Here are a few snips, emphasis in italics is mine. I encourage you to read the entire article.
In running our personal affairs, virtually all of us exploit the advantages of free trade and comparative advantage without thinking twice. For example, many of us have our shirts laundered at professional cleaners rather than wash and iron them ourselves. Anyone who advised us to “protect” ourselves from the “unfair competition” of low-paid laundry workers by doing our own wash would be thought looney. Common sense tells us to make use of companies that specialize in such work, paying them with money we earn doing something we do better. We understand intuitively that cutting ourselves off from specialists can only lower our standard of living.

Adam Smith’s insight was that precisely the same logic applies to nations. Here is how he put it in 1776: "It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy.. . . If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage."

Spain, South Korea, and a variety of other countries manufacture shoes more cheaply than America can. They offer them for sale to us. Shall we buy them, as we buy the services of laundry workers, with money we earn doing things we do well—like writing computer software and growing wheat? Or shall we keep “cheap foreign shoes” out and purchase more expensive American shoes instead? It is pretty clear that the nation as a whole must be worse off if foreign shoes are kept out—even though the American shoe industry will be better off.

If cheap Chinese labor was stealing American jobs, why did the theft intensify as the wage gap fell? The answer, of course, is that Chinese productivity was growing at enormous rates. The remarkable upward march of Chinese productivity both raised Chinese wages relative to American wages and turned China into a world competitor. To think that we can forestall the inevitable by closing our borders is to participate in a cruel self-deception. Nor should there be any worry about failing to forestall the inevitable. The fact that another country becomes wealthier does not mean that Americans must become poorer.

A slogan occasionally seen on bumper stickers argues, “Buy American, save your job.” This is grossly misleading for two main reasons. First, the costs of saving jobs in this particular way are enormous. Second, it is doubtful that any jobs are actually saved in the long run.

Many estimates have been made of the cost of “saving jobs” by protectionism. While the estimates differ widely across industries, they are almost always much larger than the wages of the protected workers. For example, one study in the early 1990s estimated that U.S. consumers paid $1,285,000 annually for each job in the luggage industry that was preserved by barriers to imports, a sum that greatly exceeded the average earnings of a luggage worker. That same study estimated that restricting foreign imports cost $199,000 annually for each textile worker’s job that was saved, $1,044,000 for each softwood lumber job saved, and $1,376,000 for every job saved in the benzenoid chemical industry. Yes, $1,376,000 a year!

While Americans may be willing to pay a price to save jobs, spending such enormous sums is plainly irrational. If you doubt that, imagine making the following offer to any benzenoid chemical worker who lost his job to foreign competition: we will give you severance pay of $1,376,000—not annually, but just once—in return for a promise never to seek work in the industry again. Can you imagine any worker turning down the offer? Is that not sufficient evidence that our present method of saving jobs is mad?

But the situation is actually worse, for a little deeper thought leads us to question whether any jobs are really saved overall. It is more likely that protectionist policies save some jobs by jeopardizing others. Why? First, protecting one American industry from foreign competition imposes higher costs on others. For example, quotas on imports of semiconductors sent the prices of memory chips skyrocketing in the 1980s, thereby damaging the computer industry. Steel quotas force U.S. automakers to pay more for materials, making them less competitive.

On balance the conclusion seems clear and compelling: while protectionism is sold as job saving, it probably really amounts to job swapping. It protects jobs in some industries only by destroying jobs in others.
China Dumps Solar Panels

Let's investigate an amusing EU point of view in regards to "clean energy" tariffs. In May of 2013, Spiegel Online reported the European Commission approved tariffs on Chinese-made solar panels in response to complaints of price-dumping.

In my article Paul Krugman "Was" Right I commented on the solar panel boondoggle ....
Please note the irony in these tariffs. The EU is hell bent on promoting "clean energy" but does not want clean energy if the cost is too cheap. Obama's position is similar.

Supposedly China is dumping solar panels below cost? So what? If the EU and US were really interested in clean energy and reducing emissions, the only thing better than cheap solar panels would be free solar panels.

Step back for a second and think of the benefits of free panels. On one side of the equation, the EU and US would lose a few hundred solar panel making jobs. However, hundreds if not thousands of businesses and individuals would employ solar panels if they were free.

Think of all the trucking jobs, dock unloading jobs, and installation jobs, that would result from free solar panels. Whatever jobs were lost in manufacturing (if any), would come back 100 times over in other jobs.
Here is a second irony.

The first sentence in the Spiegel article reads "Back in 2008, the German solar manufacturing industry was riding the crest of a wave of growth fueled by generous subsidies and high demand."

Without generous subsidies, the European solar panel manufacturers were not profitable in the first place. Yet, the EU imposed tariffs to prevent Chinese "dumping".

Paul Krugman "Was" Right

In Paul Krugman "Was" Right, I also discussed a shockingly accurate revelation from Krugman.

In 1997 Krugman wrote a brilliant article "In Praise of Cheap Labor", stating "Bad jobs at bad wages are better than no jobs at all".

I wrote about Krugman's position in Fair Trade is Unfair; In Praise of Cheap Labor; Are Bad Jobs at Bad Wages Better than No Jobs at All?

Please check it out. Krugman "Was" Right. However, the definition of "was" requires one to go back to 1997 to see just that.
Why Does Free Trade Seemingly Not Work?

The above examples show free trade only fails to work from the self-serving point of view of the industry demanding protections.

Amusingly, auto manufacturers want to use cheaper steel, but the steel industry wants protection. And whether or not the auto manufacturers get steel imports at cheap prices, they want protection from alleged subsidies of Toyota.

It's hypocritical madness its finest.

Role of Nixon

There is another facet to the free trade debate and that is in regards to huge trade imbalances between the US and China.

I have written about this so many times it is disheartening to have to point out once again the root cause. Please read, and make an attempt to understand Hugo Salinas Price and Michael Pettis on the Trade Imbalance Dilemma; Gold's Honest Discipline Revisited.

Pettis: "The capital and current accounts for any country, and for the world as a whole, must balance to zero. In the old days of specie currency – gold and silver – this meant that specie would have flowed from Spain to Germany as the counterbalancing entry, and of course this flow created its own resolution."

Hugo: "The gold standard imposed order and harmony. If President Nixon had not 'closed the gold window' in 1971, the world would be radically different today. China sells vast quantities of goods to the rest of the world, without the rest of the world having any chance of selling similar quantities to China. China can do so, because today trade deficits are “paid” not in gold, but in dollars or euros or pounds sterling or yen, which will never be scarce: they are created at will by the USA, the European Central Bank, the Bank of England, or the Bank of Japan. It is no coincidence that some analysts have observed that in real terms, American workers have had no real increase in their income since 1970. The best and brightest of today’s accredited economists attempt in vain to find a solution to a problem that cannot be solved except by the renewed use of gold as the international medium of commerce."

Enforcement Mechanism

Those are small snips from an article I wish everyone would read in entirety to fully understand where the problem is.

Pettis admits that a gold standard would address the issue, but that is not his preferred solution (which to the best of my knowledge he has never stated).

What both Michael Pettis and Hugo Salinas Price refer to is that ever since Nixon stopped paying for US trade deficits in gold, monetary expansion has been exponential. The result has been massive trade imbalances and extreme income inequality.

Problems in "Speece"

The lack of an enforcement policy also explains the problems of Greece and Spain vs. Germany.  Collectively, I  refer to (Spain, Greece, and peripheral Europe in General) as "Speece"

To properly understand the trade mess in Europe please read From ZIRP to NIRP: Virtues of Germany vs. the Vices of Greece; What About "Speece" and Gold?

Here is a key paragraph on "Speece", but to understand the ripple effect of no enforcement mechanism I suggest re-reading the entire article.
Still No Enforcement Mechanism, Anywhere

Because there were no trade imbalance enforcement mechanisms, Speece imbalances grew until they blew up. And until they blew up, the IMF had nothing but praise for Spain! And every step of the way, the IMF underestimated the problems Greece faced.

We are headed into the third Greek bailout, and the IMF remains clueless about Greece's ability to pay back "bailout" money.

Worse yet, there still is no "enforcement" mechanism anywhere in the world, and the structure of the euro is such that imbalances in Europe are even harder to fix than elsewhere.
Excellent Trade Agreement

Lack of a gold standard is a key reason "free trade" seems not to work. But the problem is not "free trade", the problem is elsewhere.

I repeat the assertion I made in Obama's Trans-Pacific Partnership Fiasco vs. Mish's Proposed Free Trade Alternative; How Will TPP Function in Practice?

An excellent free trade agreement would consist of precisely one line of text: "All tariffs and all government subsidies on all goods and services will be eliminated effective June 1, 2015."

Moreover, the first country that fully embraces free trade would come out ahead, regardless of whether or not any other country did so as well.

The logic behind those statements is impeccable.

Free Trade Never Causes Net Job Loss

Free trade is always beneficial. Lack of an enforcement mechanism, unsustainable union agreements, a loss of jobs to robotics, and incessant self-serving whining from industry groups demanding favors makes it hard for many to see the benefits.

Mike "Mish" Shedlock

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