Free Trade

“Let's see if I have this right. If free trade is now working, we should have a trade surplus, right?”
~ Blog poster nicknamed “seekingtruth123”

Why Should We Care about Free Trade?

Our blogger has a legitimate question – what is the objective of free trade? In its original form, free trade was the most efficient means of trading products between nations. Free trade was about trade. However multinationals have hijacked the term redefining it into something that is not “trade” at all – unless you count trading jobs for unemployment! It has now become an exchange of potentially lower product prices for cheap labor that eliminates the displaced jobs in the richer country. This “new free trade” isn’t about trading anything. Rather it is about global wage competition where highly paid developed nation’s workers are forced to compete with emerging nation’s lower wages brought about by a lower cost (and standard) of living. Free Trade is the policy du jour of the modern world where labor globalization is embraced by all countries (including those that have a lot to lose - the richer countries). Americans have been duped into embracing this redefined policy. It continues to have devastating effects on the US economy and may ultimately collapse the world economy. But there is nothing wrong with the original type of free trade, which dealt with directly trading products between nations.

Why Do We Trade?

The term “trade” is actually a bit outdated. The agreement on a common medium of exchange (currency) has obviated the need for direct trade transactions. So the modern notion of trade is more like a global market for products where governments step in and adjust prices or limit import or export supplies in order to compensate for differences in prices between countries, usually to protect their internal industries from the cheaper labor markets of foreign competitors. Free trade is “free” of these policies because the trading countries decide to allow the global market to rule over the sale of their products. At first glance, these compensation policies may seem like a “bad thing”, but when you understand how trade works, some degree of “protectionism” is necessary to create fair trade. In other words, excess compensation is protectionist, but balanced compensation should be expected.

Throughout history, countries have traded. For example the Dutch East India Company flourished in the 18th century because Europe provided a demand for the spices of Asia. Note that this was
not an artificial demandpeople actually wanted to pay for something they didn’t already have. In other words, there was something to trade for. So that is a legitimate foreign trade transaction, and may even pass for free trade. The same can be said for many commodities such as bananas, coffee and even minerals.

What is real Free Trade?

Free trade occurs when a country buys anther country’s products with no limits or tariffs imposed, or when a country sells its products without government subsidies. We trade for things we don’t produce. We don’t “trade” for things we already produce because that warps trade into wage competition.

Do we really want to compete Globally?

Perhaps we do want to compete with other countries in external markets, but it makes little sense to compete with them in our domestic market – that will only lead to ruin as long as our cost (and standard) of living is higher than the external competitor. As the richest country, this is a “competition” the US will always lose.

The Banana Export Company

Trade is best understood through an example. Suppose America cannot grow bananas here in the US. Bananas are grown only in Costa Rica. We demand the bananas. They produce something we do not. The Banana Export Company (BEC) of Costa Rica wants $100 per pallet. We agree and import their bananas. Done deal, the traditional “free trade” way. No tariffs, no subsidies.

So Much for Free Trade

Now an American company named ACME Biobanana Inc. (ABI) figures out a way to grow bananas in the US and can match the BEC price (assume BEC was a monopoly before, so US consumers paid whatever price they asked). US banana companies are now cutting into the market share of Costa Rica’s exports. After a while, BEC complains to their government about the US market invasion and asks for a subsidy. The Costa Rica government complies with a $25 per pallet subsidy and BEC is now able to sell their bananas for $75 per pallet to the banana market (Note: Someone has to pay for the subsidy – in this case it is the Costa Rica taxpayer). We no longer have free trade.

What Went Wrong?

It’s important to understand the point at which trade became contentious. Trade becomes politicized when countries that want to trade with each other produce the same product. In other words we are no longer trading we are in fact competing. Before the US got into the banana business, things were great. After that, Costa Rica believed that the potential jobs lost from the new competition were worth fighting for (what a concept – a government that fights for its people).

Free Trade is not as important as Fair Trade

In retaliation, US banana growers get permission from the US government to slap a $25 per pallet tariff on the imported bananas from Costa Rica and we are back to ground zero. Clearly, this is all a bit childish, but it has been going on as long as countries have been trading. From an economic perspective, it is inefficient and suboptimal – the true competitive price of a banana pallet has now become $75, regardless of the added subsidies and tariffs, which have artificially expanded the pre-competitive price to $100 per pallet. This kind of meddling in an otherwise competitive market gives traditional free trade advocates a strong argument, and most Americans would agree to eliminating the American tariff, but only if Costa Rica stops subsidizing their banana exports. Americans want traditional trade, but it is more important that trade policies are fair. As soon as we trade for things we already produce, we are competing at the wage level, and this is rarely if ever fair. To be fair, prices must be adjusted to reflect the disparity in wages between the traders.

Global Markets are not Free Markets

Free markets are great within national borders, but there are two problems with the idea of a global free market. First, there is no such thing as a global free market. Every nation has trade policies that either subsidize certain domestic industries, place tariffs or quotas on imported goods coming from competing nations. This is a normal part of the trade process. It will always occur, so the notion of a “global free market” is a fantasy. Sometimes these compensation policies are unfair to one of the trading countries. For example allowing Japan to import cars into the US tariff-free while Japan slaps tariffs on American cars would be an example of an unfair protectionist policy on the part of Japan. Another common protectionist policy is to limit the number of imports on one end of the deal more than on the other end - quotas. These are examples of excess domestic compensation (i.e. protectionism).

When is Protectionism Necessary?

It turns out there is at least one very good reason for the “protectionist” policies described above and that is the inequality in wages between nations born out of the disparity of the standard of living between nations. This is the second problem that the cost of living between nations is unequal and so protectionist policies of some form are actually necessary to ensure that the nation with the lower cost of living does not destroy the economy of the nation with the higher standard of living by indirectly contributing to the elimination of jobs. This is the goal of “free trade” and globalization – to exploit the global disparity in wages in order to maximize multinational profits. Free trade is a form of cheating the implicit rules of fairness in competition. Policies that seek to equalize the disparity in wages across trading nations are not protectionist – they are an essential accounting method to level the playing field. Let’s call them equalization policies. And so there is an important distinction between fair protectionist policies and arbitrary ones. If a trading partner refuses to compensate for a disparity in wages across nations, then the importing country has little options left than to practice equalization. Unless of course they are true believers in “free trade”…

Competing is not Trading

When two countries are competing for customers in the same market of one of the countries, the country with the lowest price always wins. Rephrased, when foreign countries compete with American goods in American markets, the foreign country always wins because their labor costs are a fraction of US labor costs. Even if we can get better prices, is it worth losing American jobs? This is the question we all must ask ourselves since it is jobs, not cheap prices that make the economy function. When people lose their jobs, the lack of a multiplier effect negatively affects the entire economy, not just the folks who lost their jobs. And without jobs, no one can spend to sustain jobs, nor can they pay taxes to share in the burden of paying for the common services we all need. Businesses can’t make a profit, so they begin to lay people off. A downward pressure is placed on wages so people can’t save or invest, new businesses will not be created and the downward cycle continues. In the long run, no one wins.

Fair Trade is better for Society than the “new” Free Trade

Most countries insist on trade policies that are fair. If we choose to import products we already produce, this complicates things because we introduce wage competition into the trade process. If the imported product is less expensive than the domestic product, the domestic market must be compensated for the disparity in labor costs. Some call this practice protectionism. We refer to it here as equalization. Although the term “protectionism” has been demonized, is it really a bad thing? Not if we value employment over investment. Why would we do this? - Because employment creates consumption, not investment. And consumption is what enables investment and savings. Without it, the economy ceases to function – we cannot save because there is nothing to “put away” and we cannot invest for the same reason. It is only excess disposable income that creates wealth in capitalism – nothing else can.

Equalization doesn’t apply to Domestic Markets

We should not advocate equalization between domestic markets – it only applies when dealing with foreign competition. For example, there should be no laws favoring one American company over another – this is the antithesis of capitalism. We do not fear “ruinous competition” in the domestic US market.

In Foreign Trade, Equalization supports the Domestic Economy; the lack thereof destroys it

So why should we “protect” our domestic markets from foreign competition? Isn’t that anti-competitive? Well, not really. Remember, it only applies to products that are cheaper. If they are more expensive (e.g. Toyotas cost more than Fords), equalization policies do not apply. But if we allow cheaper imports, competition is rigged in favor of the cheaper importer. It is already assumed that the domestic market has produced a price that is competitive domestically and so to introduce similar products into domestic markets creates a situation whereby the imported product will always win and domestic jobs will disappear. Unemployment will increase and pretty soon we find ourselves in a recession. If such policies become the norm, unemployment becomes underemployment, then poverty.

Why Doesn’t Everyone Practice Fair Trade?

If it is in the best interest of every nation to practice fair trade, why don’t they? They will as long as they are getting the raw end of the deal. But if they are getting a better deal, then they will certainly take that. This is what free trade offers them. America, sold out to multinationals, is offering no equalization to all countries of the world if they agree not to “protect” their markets. But why will they protect their domestic markets if their products are always cheaper? The answer is they wouldn’t and they don’t! A more salient question is why is America doing this? The answer that the American government has sold out to multinational interests is pretty disturbing. Unfortunately, it is true and when you think about it, it explains an awful lot about what has happened to the American economy. Many people unknowingly support the notion of free trade without having thought it through to its inevitable conclusion – a permanent reduction in the standard of living for the richer country. To put it at a personal level, one should only support free trade if they are willing to reduce they and their children’s standard of living - drastically.

Free Trade Policies are Disastrous For The World Economy

So what is the objective of free trade? If the goal is to maximize the benefit to American citizens, the recent experimentation with so-called “free trade” polices has been nothing short of a net dismal failure. In fact, it has led to the financial worldwide collapse we are now witnessing because the multinationals have killed the goose that laid the golden egg – American consumers. Without high paying jobs, there is no consumption and the world economy, well interconnected with both global supply and demand chains falls apart.

After nearly 25 years, has Free Trade been a success?

And so we come back to the blogger’s original question – has free trade succeeded? If so, we should have a trade surplus. Instead, we have the largest trade deficit in the world. Clearly this is not sustainable and we are now witnessing the beginnings of the consequences of such foolish trade policy. Some have assumed that at least some countries benefit, and as a whole someone has benefited, but who exactly is that? Before NAFTA was passed, Americans were assured that jobs would be created on both sides of the border and that wages would rise. In fact, the opposite has occurred. Any fool could have seen that American wages would fall and that as many as a million jobs would be lost, which has in fact occurred. But has the poorer country benefited? Wages in Mexico have actually fallen 25% since NAFTA was enacted! It was again the executives (and perhaps some shareholders) of the multinationals that benefited at the expense of consumers and laborers. They have benefited in the short run, but it remains to be seen what the long run consequences will be - certainly a financial collapse, perhaps civil unrest? This is the actual result of “free trade”.