Free trade is a fiction that makes America weak and poor
By MICHAEL STUMO
Most of what we read about trade is wrong.
I used to think free trade was simply the wrong choice for America. The North American Free Trade Agreement always seemed like a bad idea. My relatives lost their agricultural jobs when companies moved to Mexico. Cattle prices for ranchers were driven down by truckloads of Canadian cattle imported by U.S. meat packers. A government welfare program called Trade Adjustment Assistance paid off hundreds of thousands of workers who lost their jobs.
But now I think free trade is more than just wrong. It’s also fiction. Free trade between countries is fun to think and write about, but it simply cannot exist without the imposition of a single world government, one big labor market, and a borderless world.
Naive reporters, government leaders, and even many economists still believe that low tariffs equal free trade, however. It’s the received wisdom. It’s self-evident, and questioning this “logic” earns mockery and disdain from elites.
The true nature of the world, though, is one of strategic trade in the national interest. Industrialized countries are in a global competition for good jobs and manufacturing capacity.
Countries grow by capturing important supply chains that employ people, achieve economies of scale, and establish market dominance. Productivity grows, wages increase, workers become consumers, and consumers create demand. This is the virtuous circle.
The post-Revolutionary War United States could have chosen to remain an agrarian country with low tariffs to import cheap manufactured products from Europe. Plentiful (and immoral) slave labor, fertile crop land, and favorable weather made a good argument for focusing on agriculture. But Alexander Hamilton, in his 1789 “Report on Manufactures,” favored mercantilism and protectionism.
America subsequently developed its own industry behind tariff walls. We innovated or stole ideas from Europe. We built our own steel industry, our own railroads. It would have been cheaper in the short run to buy from Europe. But we didn’t. It was the right choice, since productive power and future wealth creation proved far more important to nation-building than short-term low consumer prices.
Germany’s Friedrich List studied the Hamilton strategy, implemented it, and helped build Germany’s industrial strength in the 1800s.
In the 20th century, Japan, South Korea, and China took similar paths to pull themselves up from impoverished countries to major industrial powers. Tariffs, industrial policy, and currency devaluation catapulted them above the growth rates of western nations.
The common thread? None of these countries used free trade as a mechanism for growth. China remains China First. Japan remains Japan First. Germany and South Korea, too. They may talk of “free trade,” but it’s not what they practice.
In the face of such self-serving behavior, the U.S. mistakenly led the way on “free trade” in recent decades, dropping tariffs first. That left us vulnerable when our trading partners chose to enrich themselves at the same time.
For example, Beijing manipulated exchange rates to lower the value of its currency (the Yuan) and raise the value of the dollar. The net result was to cheapen China’s exports and raise the cost of America’s exports. Similarly, Japan’s central bank merely declares its intent to “defend the Yen” against appreciation to hold the Yen price down and help Toyota sell more cars in the U.S.
Germany uses a world-class industrial policy to grow national champion companies like Volkswagen and to aid home-grown small- and mid-sized manufacturers in the supply chain. German banks lend to German firms for capital upgrades and also lend to foreign buyers who buy German goods. All of this is made easier because the Euro is undervalued by 25 percent.
And then there are “Value Added Taxes.” Europe has cut tariffs on American goods in the last 40 years, but also raised VAT rates. The result is that American exports still face the same border tax that they did four decades ago. But the U.S. lacks a VAT, which allows EU countries to sell to U.S. consumers nearly tariff- and tax-free.
When the media complains about a coming trade war, don’t believe it. There is, instead, constant global competition among economic nationalist nations. And countervailing duties, antidumping duties, and other tariff actions have been implemented for decades. No trade war happens.
The truth is that a global balance of trade is impacted mostly by exchange rates, not tariffs. The primary driver of the U.S. trade deficit is that the dollar remains overvalued by roughly 22 percent. This means Illinois goods and services are priced 22 percent higher in global markets. Conversely, imported products and services are made cheaper. Germany, Japan, South Korea and China are persistent trade-surplus countries primarily because their currencies are too cheap.
Industrial policy matters, too. Beijing is focused on “China 2025,” which aims to dominate key industries of the future. Japan makes a similar effort to boost national champion industries. In contrast, the U.S. lacks a concerted industrial policy. Yes, we have a disjointed mix of tax breaks, low-interest loans and programs in various levels of government. But these tools are used poorly, and we have no real response to overseas currency manipulation, subsidies, and non-tariff barriers.
The path to future American prosperity does not rest in pursuit of fictional notions of free trade. We exist in a strategic trade world. A comprehensive strategy of exchange rate management, tariffs, and industrial policy is how we can win the game. Otherwise we will continue a downward slide and simply export basic commodities to Asian industrial powerhouses that sell finished goods back to us.
Michael Stumo, CEO of the Coalition for a Prosperous America, a Washington-based nonprofit organization, wrote this piece at the request of the Illinois Business Journal.