The Decline of Free Trade? Good or Bad?

Joshua Kurlantzick published an article in Bloomberg Businessweek with a title guaranteed to gather attention: Farewell to the Age of Free Trade. He sees forces at work that will alter the relationship between international trade and economic growth that has held for the last 70 years.

"Since the end of World War II and the birth of the modern global economy, business leaders have come to accept an iron law: International trade always expands faster than economic growth. Between the late 1940s and 2013, that assumption held true. Trade grew roughly twice as fast as the world economy annually, as fresh markets opened up, governments signed free-trade pacts, new industries and consumers emerged, and technological advances made international trade cheaper and faster."

"Now this iron law may be crumbling. Over the past two years, international trade has grown so slowly that it has fallen behind the growth of the world economy, which itself is hardly humming."

Kurlantzick blames the decline in trade on the failure of emerging markets to grow as fast as expected, and on changes in corporate attitudes that have limited the desire to integrate more fully with other entities. He discusses some of the reasons why these failures occurred, suggests that there has been an increase in protectionist measures by many countries in recent years, and complains that there is no country or world leader in a position to carry the banner of free trade and push aggressively for its continued growth. He finishes with this gloomy assessment:

"An era of shrinking trade would be disastrous. The past 200 years show that trade makes the world economy more dynamic. It brings people from different countries together and links economies to each other, fostering interdependence. Leaps in scientific progress usually occur during times of growing trade and migration, because these types of exchanges create intellectual ferment. And although conflict between states can still occur, enmeshing nations in webs of trade does create incentives for countries not to fight wars against their trading partners. Restoring faith in free trade isn’t just an act of economic self-interest. It’s essential to building a more prosperous and peaceful world."

If that seems a bit overwrought, it is because it is. Times change! The only "iron" economic law is that humans will tend to be greedy. And how many would agree that periods of growing trade have been of unalloyed benefit to humanity. There are those who might claim that free trade has led to continuous economic disruption and frequent episodes of growth in inequality of wealth.

Free trade has a simple dynamic that was discussed in On the Future of Capitalism: Trade and Income Inequality. It leads to the concentration of wealth in the hands of those who control capital, and the lowering of income for those who have only labor to offer.

David E. Bonior took the occasion of President Obama’s State of the Union address to remind both the president and us that there is an inconsistency involved with promoting free trade and claiming the desire to combat income inequality. Bonior wrote an article for the New York Times titled Obama’s Free-Trade Conundrum.

"In his State of the Union address….President Obama focused on reversing the growth of economic inequality in the United States and restoring the American dream. At the same time, he also announced his support for fast track authority that would limit Congress’s role in determining the content of trade agreements."

"The president’s call follows on legislation introduced earlier this month to grant him fast-track authority as a way of forcing Congress to speed up its consideration of the Trans-Pacific Partnership, a 12-nation pact with Latin American and Asian nations."

"But Mr. Obama’s desire for fast-track authority on the T.P.P. and other agreements clashes with another priority in his speech: reducing income inequality."

It was just a month ago when we reached the twentieth anniversary of the North American Free Trade Agreement (Nafta). Bonior suggests we consider the outcome of that agreement before we rush into others.

"At Nafta’s core — and proposed for the T.P.P. — are investor rights and privileges that eliminate many of the risks that make firms think twice about moving production to low-wage countries. Today, goods once made here are being produced in Mexico and exported here for sale. Indeed, American manufacturing exports to Mexico and Canada grew at less than half the rate after Nafta than in the years before it."

"As a result, our trade deficit has ballooned. In 1993, before Nafta, the United States had a $2.5 billion trade surplus with Mexico and a $29 billion deficit with Canada. In 2012, the combined Nafta trade deficit was $181 billion, even as the share of that deficit made up of oil imports dropped 22 percent. The average annual growth of our trade deficit has been 45 percent higher with Mexico and Canada than with countries that are not party to a Nafta-style pact. The companies that took the most advantage of Nafta — big manufacturers like G.E., Caterpillar and Chrysler — promised they would create more jobs at their American factories if Nafta passed. Instead, they fired American workers and shifted production to Mexico."

A large number of people lost their jobs and ended up taking much lower paying work—if they found work at all. This flow of workers seeking low wage jobs helped keep wages from rising as competition for these positions increased. Income inequality has long been associated with international trade.

"….in the early 1990s a spate of studies resulted in an academic consensus that trade flows contributed to between 10 and 40 percent of inequality increases. Indeed, since Nafta’s implementation, the share of national income collected by the richest 10 percent has risen by 24 percent, while the top 1 percent’s share has shot up by 58 percent."

Politically conservative economists will argue that the depression of wages is countered—and even balanced—by the drop in prices of imported goods.

"But when the Center for Economic and Policy Research applied the data to the theory, they found that reductions in consumer prices had not been sufficient to offset losses in wage levels. They found that American workers without college degrees had most likely lost more than 12 percent of their wages to Nafta-style trade, even accounting for the benefits of cheaper goods. This means a loss of more than $3,300 per year for a worker earning the median annual wage of $27,500."

As the cost of trinkets has gone down, the price of shelter, education, and healthcare has continued to rise and consume a greater fraction of our income. The Walmartization of our economy provides no help in those areas.

Kurlantzick’s concerns are considerably overdrawn. "Free trade" has always been an economic idealization. In the real world large and wealthy countries rig trade agreements—such as Nafta—to benefit themselves. All countries act in support of their own interests. That is what they are supposed to do.

Let’s take a look at those economic benefits that have accrued from the last 200 years of trade—the ones of which Kurlantzick is so proud.

There is an interesting book on the history and the future of migration: Exceptional People: How Migration Shaped Our World and Will Define Our Future by Ian Goldin, Geoffrey Cameron, and Meera Balarajan. These authors tell us just about anything we might wish to know on the subject of migration. In the process they provided some interesting data on income inequality between countries.

"Today the wage disparities between countries are larger than ever before, and the processes of globalization appear to be exacerbating inter-country inequality....The income gap between the richest country and the poorest country in the world about 250 years ago was about 5 to 1, whereas today it is about 400 to 1."

How are we doing in recent times, particularly in the age of free trade and globalization? Branko Milanovic, a World Bank economist, computed the GDP per capita over time for 144 countries, and applied the standard formulation to determine a Gini coefficient for the world. In this formulation, all countries, no matter the size, are a single data point. His results are presented below.

So globalization and free trade not only lead to income inequality within countries, they apparently lead to income inequality between countries.

If a country chooses to maintain a domestic food supply, even if imported food is cheaper, that can be a smart thing to do. If a country does not choose to cede an entire industry, and its associated technology, to another country, that might be a very smart decision as well. If the efficiency of importing goods rather than producing them domestically is compelling, then an import duty is a good way to cover the costs of the economic disruption that will ensue. Trade will continue, but let’s base it on mutually beneficial considerations and on a case-by-case basis, rather than on ancient dogma propagated by misguided economists.