Globalization, Trade And NAFTA: A Defense of Trade Agreements

Free trade is good. Does anyone disagree? Even “fair traders” agree today. We do not hear about nakedly protectionist domestic content legislation anymore. The “fair traders” argue instead for the need for a “fair playing field” on issues like environmental and labor standards.

But is this new emphasis on equal labor and environmental standards really about anything but protectionism? Is there really an expectation of that countries like Peru, Mexico and the Central American countries (not to mention China and India) will meet US labor and environmental standards? the irony is of course that this would be a form of erstwhile globalization – an attempt to impost US standards on the Thrid World – if it were sincere. It is not. It is just a new way of defending an old idea – protectionism.

I think the evidence of this is obvious – in no other context do we see a drive for higher labor and environmental standards in the Third World. Consider the issue of climate change:

. . . George Bush pulled the US out of the Kyoto treaty, which requires 36 industrial nations to cut greenhouse emissions by at least 5 per cent from 1990 levels by 2012. The US president says Kyoto unfairly burdens rich countries while exempting developing ones such as China and India.

Developing nations say rich states built up their economies without emissions restraints and argue that less-developed countries should have the same opportunity to establish their economies now.

But as emissions from places such as China and India grow, environmentalists say action by the developed world alone will not be enough to stop the warming trend.

Does anyone think George Bush shares the concern of environmentalists on this? Or is it an excuse? And does anyone really think Mexico, Peru and the Central American countries are comparable to China and India on this? Of course not. This is pretext for protextionism.

More.

And the reasons are clear, no one is a saint. Everyone looks out for their own interests. It so happens that for the MAJORITY of Americans, free trade is a clear benefit on many levels. Alan Blinder explains:

. . . Suppose the average American worker earns ten dollars per hour, while the average Japanese worker earns just six dollars per hour. Won't free trade make it impossible to defend the higher American wage? Won't there instead be a leveling down until, say, both American and Japanese workers earn eight dollars per hour? The answer, once again, is no. And specialization is part of the reason.

If there were only one industry and occupation in which people could work, then free trade would indeed force American wages close to Japanese levels if Japanese workers were as good as Americans (and who doubts that?). But modern economies are composed of many industries and occupations. If America concentrates its employment where it does best, there is no reason why American wages cannot remain far above Japanese wages for a long time—even though the two nations trade freely. A country's wage level depends fundamentally on the productivity of its labor force, not on its trade policy. As long as American workers remain more skilled and better educated, work with more capital, and use superior technology, they will continue to earn higher wages than their Japanese counterparts. If and when these advantages end, the wage gap will disappear. Trade is a mere detail that helps ensure that American labor is employed where, in Adam Smith's phrase, it has some advantage.

Those who are still not convinced should recall that Japan's trade surplus with the United States widened precisely as the wage gap between the two countries was disappearing. If cheap Japanese labor was stealing American jobs, why did the theft intensify as the wage gap closed? The answer, of course, is that Japanese productivity was growing at enormous rates. The remarkable upward march of Japanese productivity both raised Japanese wages relative to American wages and turned Japan into a ferocious competitor. To think that we can forestall the inevitable by closing our borders is to participate in a cruel self-deception.

Americans should appreciate the benefits of free trade more than most people, for we inhabit the greatest free trade zone in the world. Michigan manufactures cars; New York provides banking; Texas pumps oil and gas. The fifty states trade freely with one another, and that helps them all enjoy great prosperity. Indeed, one reason why the United States did so much better economically than Europe for two centuries is that we had free movement of goods and services while the European countries “protected” themselves from their neighbors. To appreciate the magnitudes involved, try to imagine how much your personal standard of living would suffer if you were not allowed to buy any goods or services that originated outside your home state.

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 estimated that in 1984 U.S. consumers paid $42,000 annually for each textile job that was preserved by import quotas, a sum that greatly exceeded the average earnings of a textile worker. That same study estimated that restricting foreign imports cost $105,000 annually for each automobile worker's job that was saved, $420,000 for each job in TV manufacturing, and $750,000 for every job saved in the steel industry. Yes, $750,000 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 steelworker who lost his job to foreign competition: we will give you severance pay of $750,000—not annually, but just once—in return for a promise never to seek work in a steel mill again. Can you imagine any worker turning the offer down? Is that not sufficient evidence that our present method of saving steelworkers' 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 imposes higher costs on others. For example, quotas on imports of semiconductors sent the prices of memory chips skyrocketing in the eighties, thereby damaging the computer industry. Steel quotas force U.S. automakers to pay more for materials, making them less competitive.

Second, efforts to protect favored industries from foreign competition may induce reciprocal actions in other countries, thereby limiting American access to foreign markets. In that case export industries pay the price for protecting import-competing industries.

Third, there are the little-understood, but terribly important, effects of trade barriers on the value of the dollar. If we successfully restrict imports, Americans will spend less on foreign goods. With fewer dollars offered for sale on the world's currency markets, the value of the dollar will rise relative to that of other currencies. At that point unprotected industries start to suffer because a higher dollar makes U.S. goods less competitive in world markets. Once again, America's ability to export is harmed.

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.

I think this is an unremarkable argument in that is is blindingly obvious. But let's consider what some smart people who understand this but are more torn on the subject now think. Let's consider Paul Krugman's take from a 1990s MIT paper:

. . . One way to answer the demand for harmonization of standards, then, is to go back to basics. The fundamental logic of free trade can be stated a number of different ways, but one particularly useful version – the one that James Mill stated even before Ricardo – is to say that international trade is really just a production technique, a way to produce importables indirectly by first producing exportables, then exchanging them. There will be gains to be had from this technique as long as world relative prices differ from domestic opportunity costs – regardless of the source of that difference. That is, it does not matter from the point of view of the national gains from trade whether other countries have different relative prices because they have different resources, different technologies, different tastes, different labor laws, or different environmental standards. All that matters is that they be different – then we can gain from trading with them.

This way of looking at things, among its other virtues, offers an en passant refutation of the instinctive feeling of most non-economists that a country that imposes strong environmental or labor standards will necessarily experience difficulties when it trades with other countries that are not equally high-minded. The point is that all that matters for the gains from trade are the prices at which you trade – it makes absolutely no difference what forces lie behind those prices. Suppose your country has been cheerfully exporting airplanes and importing clothing in return, believing that the comparative advantage of your trading partners in clothing is “fairly” earned through exceptional productive efficiency. Then one day an investigative journalist, hot in pursuit of Kathie Lee Gifford, reveals that the clothing is actually produced in 60-cent-an-hour sweatshops that foul the local air and water. (If they hurt the global environment, say by damaging the ozone layer, that is another matter – but that is not the issue).You may be outraged; but the beneficial trade you thought you had yesterday has not become any less economically beneficial to your country now that you know that it is based on these objectionable practices. Perhaps you want to impose your standards on these matters, but this has nothing to do with trade per se – and there are worse things in the world than low wages and local pollution to excite our moral indignation. . . .

Krugman is not necessarily endorsing these views but he is accepting that they are factually correct. What has Krugman said more recently? This:

Let me spare you the usual economist's sermon on the virtues of free trade, except to say this: although old fallacies about international trade have been making a comeback lately (yes, Senator Charles Schumer, that means you), it is as true as ever that the U.S. economy would be poorer and less productive if we turned our back on world markets. Furthermore, if the United States were to turn protectionist, other countries would follow. The result would be a less hopeful, more dangerous world.

Yet it's bad economics to pretend that free trade is good for everyone, all the time. ''Trade often produces losers as well as winners,'' declares the best-selling textbook in international economics (by Maurice Obstfeld and yours truly). The accelerated pace of globalization means more losers as well as more winners; workers' fears that they will lose their jobs to Chinese factories and Indian call centers aren't irrational.

Addressing those fears isn't protectionist. On the contrary, it's an essential part of any realistic political strategy in support of world trade. That's why the Nelson Report, a strongly free-trade newsletter on international affairs, recently had kind words for John Kerry. It suggested that he is basically a free trader who understands that ''without some kind of political safety valve, Congress may yet be stampeded into protectionism, which benefits no one.''

. . . The point is that free trade is politically viable only if it's backed by effective job creation measures and a strong domestic social safety net. And that suggests that free traders should be more worried by the prospect that the policies of the current administration will continue than by the possibility of a Democratic replacement.

What is Krugman saying here? He is saying that attacks on free trade and trade agreements is scapegoating (like attacks on immigration, legal or otherwise) for failed domestic policies that have caused worker discontent, income inequality, economic hardship and uncertainty.

He argues that of course a politician can not be purely rational and intellectual on this issue but should focus on the issues that can effect real change to the problems besieging America.

In short, free trade is not the problem. The policies of the Bush Administration are the problem. To further demonstrate this, let us consider the attacks on NAFTA. John Edwards falsely claims NAFTA has cost the United States a million jobs:

John Edwards made this claim about the North American Free Trade Agreement (NAFTA): “It's cost us a million jobs.”

That's a disputed estimate. Other economic studies have produced far lower numbers. The million job figure comes from the Economic Policy Institute, a liberal think tank in Washington with ties to the labor movement. EPI estimated that the growth of exports since 1994 has supported an additional 1 million jobs in the US, while imports have displaced domestic production that would have supported 2 million jobs, leaving a net loss of 1 million. EPI's detractors state that EPI's estimate assumes that NAFTA is to blame for 100% of the growth in the trade deficit between the US and both Canada and Mexico and that it ignores other factors.

Whatever the effects of NAFTA, the US has gained nearly 26 million jobs since the agreement took effect on Jan. 1, 1994, according to the Bureau of Labor Statistics.

Consider the CBO Report on NAFTA:

The challenge in assessing NAFTA is to separate its effects from the effects of other factors that have influenced trade between the United States and Mexico. Those factors include the considerable economic and political turmoil that occurred in Mexico in the early post-NAFTA years–turmoil that, for the most part, was unrelated to the agreement–and the long U.S. economic expansion that lasted throughout most of the 1990s. The Congressional Budget Office (CBO) used a statistical model of U.S.-Mexican trade to separate out the effects of those factors and reached the following conclusions:

U.S. trade with Mexico was growing for many years before NAFTA went into effect, and it would have continued to do so with or without the agreement. That growth dwarfs the effects of NAFTA.

NAFTA has increased both U.S. exports to and imports from Mexico by a growing amount each year. Those increases are small, and consequently, their effects on employment are also small.

The expanded trade resulting from NAFTA has raised the United States' gross domestic product very slightly. (The effect on Mexican GDP has also been positive and probably similar in magnitude. Because the Mexican economy is much smaller than the U.S. economy, however, that effect represents a much larger percentage increase for the Mexican economy.)

Some observers look at NAFTA's effects on the U.S. balance of trade with Mexico (the difference between the values of exports and imports) as an indication of the economic benefit or harm of the agreement. The balance of trade dropped substantially after NAFTA took effect and has declined further in more recent years, leading some people to conclude that NAFTA has been bad for the U.S. economy.

However, changes in the balance of trade with a partner country are a poor indicator of the economic benefit or harm of a trade agreement. A better indicator is changes in the levels of trade. Increases in trade–both exports and imports–lead to greater economic output because they allow each nation to concentrate its labor, capital, and other resources on the economic pursuits at which it is most productive relative to other countries. Benefits from the greater output are shared among the countries whose trade increases, regardless of the effects on the trade balance with any particular country. Such effects do not translate into corresponding effects on the balance of trade with the world as a whole; for a country as big as the United States, that balance is largely unaffected by restrictions on trade with individual countries the size of Mexico. Moreover, even declines in a country's trade balance with the world have little net effect on that country's output and employment because the immediate effects of those declines are offset by the effects of increased net capital inflows from abroad that must accompany those declines.(2)

Furthermore, CBO's analysis indicates that the decline in the U.S. trade balance with Mexico was caused by economic factors other than NAFTA: the crash of the peso at the end of 1994, the associated recession in Mexico, the rapid growth of the U.S. economy throughout most of the 1990s, and another Mexican recession in late 2000 and 2001. NAFTA, by contrast, has had an extremely small effect on the trade balance with Mexico, and that effect has been positive in most years.

Besides increasing trade, NAFTA has had a substantial effect on international investment. It has done so for at least two reasons. First, it eliminated a number of Mexican restrictions on foreign investment and ownership of capital. Second, by abolishing tariffs and quotas, NAFTA made Mexico a more profitable place to invest, particularly in plants for final assembly of products destined for the United States. However, it is difficult–if not impossible–to separate the increases in foreign investment in Mexico that resulted from NAFTA from the increases caused by prior liberalization of Mexico's trade and other economic policies. Modeling such investment flows and their effects on the U.S. economy is similarly difficult. Consequently, this paper does not examine NAFTA's effects on investment in any detail but instead concentrates on the agreement's effects on trade.

NAFTA has benefitted all of the countries involved on issues as diverse as economic development, creating markets for American goods, IMMIGRATION (if there are jobs in Mexico, immigration to the US becomes less attractive) and just plain fairness and common good.

Of course, as Krugman states, there are winners in losers in trade, just as there are in all free markets. The losers feel it directly and make considerable noise about their losses. This is their right in a free political system. The winners do not see it or think about it. Consider Iowa:

Iowa's ambivalence is all the more remarkable because the state is on the whole a big winner from global trade. “Iowa, as much as any other state, is on the plus side of the ledger,” says James Leach, a 30-year Republican congressman from Iowa who now runs Harvard University's Institute of Politics. “It would be highly ironic if pro-protectionist candidates prevailed in the Iowa caucuses.” Trade wasn't always such a high priority: In the 2004 Iowa caucus, Richard Gephardt, the most outspoken Democrat on the issue, attracted so few votes he subsequently pulled out of the race.

The fallacy in the analysis of Jim Leach is that the beneficiaries of free trade do not associate it with free trade policies. Those who have suffered from free trade DO.

The reality is that the populist rhetoric against trade agreements is just more in the base line of Know Nothingism that has historically marred populist movements. This has always been the dangerous side of populism.

There is no rational argument against NAFTA, CAFTA or free trade. There is the emotional populist argument. It is a political reality, as Paul Krugman states, but it is not based on reality.