By Lorenzo L. Perez*
For many years, there has been support in the United States for free trade and a multilateral approach in formulating trade rules and resolving trade disputes. At the same time, there have been exceptions to free trade in the agricultural sector and other areas, and there have been disputes regarding government assistance to certain sectors, the multilateral dispute settlement mechanism itself, government procurement, and intellectual property. More recently, in the wake of the criticisms of globalization and the growing bilateral trade deficit with China, as well as the complaints from some sectors that feel neglected, American administrations have taken flagrant protectionist actions. The Trump administration-imposed tariffs on steel and aluminum under the pretext of “national security grounds,” and the tariffs have been imposed on Chinese imports. These tariff increases have not been removed by the Biden administration. This article analyzes whether this approach is beneficial for the common good by discussing the merits of free trade, the effects of trade protection, what causes trade deficits, the impact of trade on employment, and some of the areas where government intervention in international trade is permitted according to multilateral rules.
The case for free trade
Economics teaches that countries should produce those goods which they can produce most cheaply, sell them to buyers in other countries, and in return buy the goods that are more cheaply produced abroad¹. The comparative advantage argument maintains that countries will be much better off producing the goods that they can do more cheaply and importing the other goods even when they could produce all goods cheaper than trading partners.² Free trade also encourages innovation and competition resulting in productivity increases in all countries. Under free trade, consumers have a wider variety of goods and services from which they can choose. Professor Anne O. Krueger points out in her book the considerable historical evidence for open trade policies’ success in supporting economic growth and higher living standards. That was the case for Great Britain in the nineteenth century when it was the first country to remove trade barriers and adopt a policy of free trade. The removal of trade and exchange restrictions was an important element in the rapid reconstruction and sustained growth of the European economies. Some Asian countries beginning in the 1960s, particularly South Korea, also benefitted from a strong trade liberalization which resulted in an export boom and strong growth after 1960.
1 In this article, I am drawing from sections of a recent book written by my former supervisor at the International Monetary Fund and an authority in international economics, Professor Anne O. Krueger (former World Bank Chief Economist and former First Deputy Managing Director of the International Monetary Fund (IMF)): “ International Trade: What Everyone Needs to Know”, Oxford University Press, 2020.
2 For a more detailed discussion of the comparative advantage argument based on the writings of Adam Smith and David Ricardo, see Krueger, op. cit., pages 52-54.
Because of all these reasons, it can be argued that the existence of free trade will tend to maximize the common good. However, some objections have been raised to the comparative advantage argument. Developing countries have insisted that they need to protect “infant industries” so that they can develop sufficiently to compete on an equal footing with the same industries in advanced countries. But when protection, is used these infant industries seldom mature. Other policy makers argue that a foreign producer might sell its product in the exporting market at below cost to attain a dominant position that may later be exploited. It may also be the case that a government subsidizes the production of a good so that firms could sell below their economic cost abroad. More recently, concern has grown in the United States that competition from abroad can harm some occupations in particular or some geographical locations in which other employment cannot rapidly be found.
The problem with trade protection
Imposing a tariff or other protective device reduces the number of goods and services that could be enjoyed by the citizens of a country³. In many cases, protection helps the few at the expense of the general public and it also harms workers by limiting growth. Protection of some sectors entails discrimination against other sectors. If the prices of imported goods increase as a result of protection (e.g., an import tariff), those increases constitute an increase in relative profitability of producing the commodities covered by the tariff rate increase and a decrease in the relative profitability of producing other commodities. The resource allocation is thus distorted in the country, limiting growth. The protection of import-competing producers is also particularly discriminatory against exports when the imported good, such as steel or a textile product, is used in the production of machinery or clothing that may be exported. This may force exporters to increase their prices and lose competitiveness vis-a vis foreign producers.
All these arguments are well known, but policy makers sometimes give in to powerful corporate or union interests and impose trade restrictions. More recently, it has become fashionable to criticize globalization and use nationalistic rhetoric to justify the imposition of trade barriers. It is difficult not to conclude that these actions damage the common good.
3 There are many forms of protection. In addition to tariffs, there are non-tariff barriers (NTBs) that also raise the domestic price of an imported good above and beyond the normal markup from factory abroad or port to retail outlet. Another form of protection is making domestic regulations such as testing procedures for safety standards more rigorous for imports.
Trade Deficits — or More Appropriately Current Account Deficits
Trade deficits (or more correctly current account deficits which include the net external service balance of a country) are not the result of the trade barriers of other countries. The current account balance of any country is the difference between domestic expenditures and domestic savings (both private and public). The current account balance is the outcome of private decisions which are influenced by fiscal and monetary policies in a market economy like the United States. Unless trade protection affects either aggregate domestic savings or investment in the country imposing them (unlikely in a country with the size of the domestic economy of the United States), they will not correct current account deficits. Concerns about current account deficits need to be addressed by fiscal and monetary policies.
While a current account deficit cannot be imputed to trade barriers of other countries, it does not mean that trading countries should not be concerned about protectionist actions or actions that give an unfair advantage to firms of their trading partners. Mention has been made already of government assistance to national industries that violate multilateral trading rules (export subsidies). Negatively affected countries have a right to seek recourse to multilateral agreements to end these practices. The most notorious case is China, which in many cases gains market share through these practices.
But should the U.S. be concerned about the large bilateral deficit with China in addition to getting redress from the objectionable trade practices of China? If the U.S. current account deficit is the excess of expenditures over saving, it is difficult to think of measures that China could take to significantly reduce the current account deficit of the United States. The Trump administration urged China to increase its purchases of soybeans from the United States. Professor Krueger rightly points out that had it done so, either China would have bought fewer soybeans from other countries or it would have increased its expenditures relative to its savings⁴. If China had simply changed its sources of supply, U.S. farmers would have offset part of their increased sales of soybeans to China with reduced sales to other countries. If China had bought more U.S. beans, American farmers would also likely have bought additional goods and services with their additional income. Unless farmers had saved more, the increased expenditures would have offset at least part of the increased income.
Economic authorities must be concerned about current account balances.
4 Krueger, op. .cit., pages 79-80.
The need for a policy response depends on a number of factors: whether a current account deficit is being caused by an increase in investment over saving which may generate future sources of income or by simply an increase in consumption that may prove unsustainable; and the extent that the current account deficit can be financed externally or by a draw down in international reserves. The United States has an advantage over other countries in financing a current account deficit because the U.S. dollar is the most important reserve currency in the world, and other countries are willing to hold U.S. government securities as part of their international reserves⁵. This is not the case of most countries in the world, particularly of developing countries where large current account deficits combined with a closing of foreign capital markets and an exhaustion of international reserves cause economic crises.
Impact of Trade on Employment
Policy makers are tempted to raise trade barriers to protect jobs in industries affected by foreign competition. However, spillover effects of protection need to be taken into account; the reduction of demand, damage to the competitiveness of industries using the commodities subject to increased protection, and the ability of other countries to export to the United States and thus leading to reduced exports from the U.S. all must be acknowledged. The existence of these spillover effects makes attempts to create jobs through protection very costly per job saved. In fact, it may even cost jobs in the protected industry.⁶
It also needs to be pointed out that a variety of factors lead to the close of businesses and loses of jobs, Poor management, import competition, changes in tastes, innovation, substitution of capital for labor, and increased competition from other products all can play a role. Attempts to prevent job losses through protective policies can be very crude instruments and are condemned to failure. It also must be acknowledged that as real wages rise in the United States, those activities relying heavily on unskilled workers experiences a larger increase in their costs than industries relying on capital equipment. Typically, there is a substitution of capital for labor as the real wage of unskilled labor rises independently of the degree of import competition.
The case of using protection to save jobs is further weakened by the increase of supply chains across various industries and countries. An increasing number of producers is fabricating or assembling products that are used as inputs in the next stage of production. When any of those early-stage products are protected, the companies that purchase their output for the next-stage of production have higher costs. Foreign producers of goods competing with the next-stage industry can purchase their inputs more cheaply than can domestic producers of the tariff-ridden good, and not too many jobs will be saved in the country introducing protective measures.
The question arises for policy makers whether and how to help workers who have lost their jobs due to trade competition. From a Catholic Social doctrine perspective, solidarity would call for some assistance program for these workers. In the United States, there is a program (Trade Adjustment Assistance-TAA originally approved in 1962) to help displaced workers due to foreign competition.
5 It is worth mentioning that China is the main holder of US Treasury bills.
6 Krueger, op. cit., has a through discussion of this topic.
However, the TAA has proven ineffective, because the implementation of the program faces the reality sometimes that job dislocation comes from factors other than trade, such as technological change or changes in consumer demand. Consequently, many times workers do not qualify for assistance⁷. In this context, the U.S. would benefit from imitating the practices of some other developed countries. In some Nordic countries and in Germanys all the various labor support programs are brought under one agency and provide labor market integration programs for those looking for work, including the unemployed (for whatever reason), the underemployed, and those searching for a better job. This approach has become known as “active labor market policies” (ALMPs). Under ALMPs, there is coordination of all types of support for those seeking help in job search. The provision of information about job openings; about skill requirements for various types of work and training centers where they may be learned; about financial support for those in training or seeking work are available through this approach.
Government interventions in international trade
To facilitate international trade, there must be rules governing international trade transactions and a mechanism for enforcing them. The General Agreement on Tariffs and Trade (GATT)/World Trade Organization (WTO) has fulfilled this role well.⁸ As of August 2019, the WTO had 164 member countries, representing 98 percent of world trade.⁹ Its basic functions are to provide a forum in which members can set rules and arrangements for trade that all its members agree to follow; provide for the resolution of disputes about whether the rules have been followed; serve as the secretariat for multilateral trade negotiations; and improve transparency of the trade system and trade policies. In addition, understandings have been established on custom formalities, trade facilitation for low-income countries, intellectual property protection, regulations governing the establishment of standards and technical barriers to trade, and government procurement.
Under the multilateral rules of the WTO, trade actions are permitted to offset dumping by foreign producers (anti-dumping duties) and countervailing duties to offset export duties. These are the most commonly used remedies by WTO members, with the US and India being the main users of these instruments. There is also a safeguard provision in the WTO in response of pressures by some countries who fear that a sudden flood of imports might destroy a domestic industry. Most of the safeguard measures were taken in the early years of the GATT.
7 Bown, Chad and Caroline Freund, 2019. “Active Labor Market Policies: Lessons from Other countries for the United States”. Peterson Institute for International Economics, Working Paper No. 19-2, Washington, D.C.
8 The General Agreement on Tariffs and Trade (GATT) was created at the end of the Second World War to provide a multilateral framework for international trade and reduce tariffs. In 1995, the GATT was transformed into the World Trade Organization (WTO) following the Uruguay round of multilateral trade negotiations. The WTO took over the role of the GATT and its role was expanded beyond the original GATT areas.
9 Krueger, op. cit., page 146.
These remedial actions provide the useful political role of rallying support for multilateral reductions of trade barriers by ensuring that there can be remedies available to counter unexpected negative situations.¹⁰
There are also some gray areas where trade restrictions, not necessarily sanctioned by the WTO, are sometimes considered or introduced. These include restrictions relating to environmental and health concerns, and more recently cybersecurity and network issues. It makes sense to subject imports to the same standards that domestic companies have to follow, but the problem is that some of these measures can be abused for protection purposes.
Another old issue that has received more attention due to the recent situation in China is whether to restrict imports from areas were forced and/or child labor are used or where deplorable working conditions exist. People of goodwill are called to oppose trade under these conditions even though it may result in importing from higher cost locations.
This article argues that there are reasons to continue to support free trade from a common good perspective. It shows the problem with trade protection measures and emphasizes the need to look at the current account balance and no the trade balance. It also points out the pitfalls of looking at bilateral trade balances instead of the current account transactions with all trading partners. It stresses that current account objectives can be achieved only with monetary and fiscal policies. It advocates for broader labor assistance programs instead of a program associated with employment disruptions due to international trade because, among other things, of the difficulties in determining to what extent job losses are caused by imports. Finally, the article supports a multilateral approach to trade policy through the WTO. Enforcing discipline in trade practices is likely to be more successful if like-minded countries join forces.
10 There are other trade remedies under the WTO like the nullification of a previously granted tariff reductions that are not discussed here.
- Lorenzo L. Pérez, PhD. Economics, University of Pennsylvania is a retired economist who worked for over 30 years at the IMF, and prior to that worked at the Agency for International Development and the U.S. Treasury Department.
Mr. Perez is a resident columnist of El Ignaciano.