In Defense of Free Trade

Milton Ezrati

DONALD TRUMP more or less runs the show on world trade these days. That leaves the United States and the rest of the world in considerable need of clearer direction and more prudence than they have heretofore experienced. At the very least, the president’s contradictory rhetoric and actions have made it all but impossible for nations to respond in a coherent fashion. And while some wonder how to engage the White House, Trump’s belligerent manner and complete lack of caution invite comparable behavior in others. The whole package has placed the United States and the world at risk of recession—or worse. Trump’s agenda, if it deserves that name, may have successes, but it has more potential drawbacks than benefits, and history shows that some of those are downright terrifying. There is no getting away from it; this White House is playing with fire. 

In this precarious situation, it hardly helps that Trump’s critics have abandoned all subtlety. Though they are loath to admit it, the president does have a point: China, and to a lesser degree the European Union (EU), have consistently sought unfair advantages that hardly constitute free or fair trade and that have hurt the U.S. economy and others. Many would benefit if China, the EU and others who have gamed the system were brought back under more equitable rules. Nor is it reasonable to claim, as Trump’s critics have, that he aims to destroy the “rules-based” trading system that this country created after the Second World War and has championed ever since. That claim is nonsense. The original U.S. push for universal free trade died decades ago. It was replaced by a scramble for what diplomats call “free trade agreements” but which should more properly be called preferential trade agreements (PTAs), as they allow freer trade among signatories but otherwise exclude and seek advantages over most of the rest of the world. Though it falls far short of free trade, perhaps the current practice deserves protection from Trump anyway, but a little realism about what people are protecting would help.

THE SMOOT-HAWLEY Tariff Act lies behind people’s legitimate fears of Trump’s tariffs and belligerence. That old piece of legislation was conceived and passed for the best of reasons. 

After the market crash of 1929, Senator Reed Smoot and Congressman Willis C. Hawley wanted to protect American jobs from foreign competition. They framed legislation that placed tariffs of between 20 and 60 percent on imports of some twenty thousand products. President Herbert Hoover signed it into law on June 17, 1930.

More than even the most elegant and persuasive economic theories, the Smoot-Hawley experience has eloquently made the case for open trade and against trade restrictions. By raising the prices of imports, those tariffs immediately raised living costs for millions of Americans at a time when most could ill afford it. Not only did the tariffs raise the prices of imports, but by raising costs throughout the supply chain, they also imposed rising costs on even purely domestic producers. The attendant drop in demand led to production cutbacks, falling profits and layoffs, all of which exacerbated the already difficult economic situation. What is more, the tariffs invited retaliations from trading partners. Their tariffs kept out American products, further limited American sales and also subjected retaliators to the same economic ills besetting the United States. Those adverse effects further depressed global economic activity so that a downward economic spiral fed on itself.

The economic statistics from that time are compelling. In the quarters and years after the tariffs went into effect, global trade collapsed. U.S. imports fell 40 percent but exports fell an even steeper 75 percent. American farmers lost 20 percent of their wheat sales, 40 percent of their tobacco sales and 55 percent of their cotton sales. World trade shrank some 67 percent in the two years following the bill’s passage, reversing the previous forty years of global economic integration. It is impossible to disentangle the effects of trade restraint from other adverse influences on the U.S. and world economies, but the evidence suggests that Smoot-Hawley made the difference between what would have been a severe recession and the Great Depression that actually occurred. It is noteworthy in this regard that the unemployment rate, which had risen in early 1930 to some 9 percent of the workforce, had already fallen to 6.3 percent by June—just before the tariffs went into effect. It would seem that the economy was on the mend. After the tariffs took hold, unemployment rose to more than one-quarter of the country’s workforce. The stock market anticipated the economic harm: on the day the Smoot-Hawley tariffs became law, stock prices crashed 10 percent.

It was primarily this ugly experience that impelled the United States to promote free trade during and after the Second World War. From FDR through Truman, Eisenhower, Kennedy and into Johnson’s administration, the country pressed for the universal elimination of tariffs, quotas, subsidies and trade restraints in general. Washington pursued no special trade arrangements with individual trading partners or groups of them. Rather, it advanced its agenda through the General Agreement on Tariffs and Trade (GATT), the precursor to the World Trade Organization. In a series of what came to be called “rounds,” representatives of the world’s trading nations met and agreed to reduce tariffs and other restrictions. The so-called Kennedy Round in the 1960s alone reduced tariffs 10 percent across the board. Surely, some of the world’s remarkable economic growth during this time was due to these efforts.

Washington began to change its approach during the last third of the twentieth century. Nixon took the dollar off gold in 1971, mostly to punish Japan and Germany for refusing to revalue their currencies up from levels set in the late 1940s when they were far less than the economic powers they had become. As Washington began to consider advantage in trade and relative U.S. economic power waned, the GATT effort lost force, and with it, so did the whole push for universal reductions in trade restrictions. By the 1980s, the rise of Japan as an economic powerhouse made Washington turn to special bilateral arrangements with Tokyo to contain what it saw as an economic threat. At the same time, Europe had secured its own preferential trade agreement in what was a precursor to the European Union. Though European structures opened trade among EU members, they offered signatories protections against competition from outsiders, most particularly in agriculture. It and other trading nations thwarted a further GATT effort to reduce trade restrictions. It took time for the GATT effort to die, but it finally did when the so-called Doha round languished for seven years before finally failing in July 2008.

During this extended period of decline, world powers turned increasingly toward PTAs. For some, these offered a second-best solution to the failing universal approach. For others, they offered a way to attain an advantage. Diplomats and politicians, in the spirit of the earlier effort, insisted on calling these treaties “free trade agreements.” President George H.W. Bush negotiated the North American Free Trade Agreement (NAFTA) in the 1980s, which President Bill Clinton signed into law in the early 1990s. This deal did implement free trade between its signatories (the United States, Canada and Mexico), but not for anyone else. The EU, for its part, secured greater freedom among its members but continued to subsidize its industry against foreign competition, impose tariffs and authorize quotas. If the Trans-Pacific Partnership (TPP) had succeeded, it also would have had the same PTA qualities—it pointedly excluded China from what was primarily an Asian arrangement. If it had gone into effect, so too would the Transatlantic Trade and Investment Partnership (TTIP), which excluded many nations that had trade relations with the negotiating countries.

ENTER TRUMP. While his White House has said little about earlier U.S. trade policy, Trump has declared the PTA-centered approach of the last few decades a failure. He claims that the United States has played by the system’s rules but that others have either cheated or manipulated the terms of PTAs to their advantage and to America’s disadvantage. From what the White House has done and said, it is possible to tease out what looks like a two-pronged fix for what Trump believes is broken. The first prong would step away from PTAs or renegotiate them to get a better deal for the United States. The second prong would force trading partners, mainly the EU and, more pointedly, China, to cease their less-than-forthright behavior and proceed more in the spirit of free and open trade. 

Trump accordingly ended negotiations on the TPP and renegotiated NAFTA. The former was near death anyway by the time Trump came to power. The TTIP was already a dead issue. On NAFTA, he added to the confusion about his guiding principles, if any, by using this country’s overwhelming economic power to bully concessions out of Canada and Mexico that aim more to disadvantage the two other members of the agreement than to even the scales as Trump claims. On the basis of this behavior, Trump could be labeled an economic nationalist or even a mercantilist.

In other respects, Trump played a clearer, seemingly more principled, hand. When he walked out of the G7 meetings earlier this year, he told the other members that he would talk when they were ready to remove all tariffs, quotas and subsidies. Making such a statement to the leaders of the six other richest nations in the world—Japan, Germany, the United Kingdom, France, Italy and Canada—suggests perhaps that under all the noise Trump might aim at returning to the older U.S. policy of striving to erase trade impediments universally.

But even as Trump hints in this rather welcome direction, much else that he does contradicts such objectives. He could be saying that he prefers the elimination of all such barriers but as long as others remain unwilling he will fight for the best deal. Yet his position is hardly clear. That lack of clarity is more than just frustrating—it makes the give and take of negotiation all but impossible. Worse, it invites unhelpful responses as well as unintended and undesirable consequences.

For the second prong of this effort, the White House has concentrated on China. To bring Chinese misbehavior to heel, the Trump team has placed tariffs on Chinese imports to the United States and threatened more until Beijing bows on three major matters: 1) to import more from the United States, creating a less skewed balance of trade; 2) to have China cease cyber theft; and 3) to end Beijing’s insistence that every foreign business in China have a Chinese partner to which the foreign firm must reveal its commercial and technological secrets. Beijing has heard all this before. American presidents going back at least to Bill Clinton have made such demands and in turn received Beijing’s assurances—most recently and dramatically in a deal reached between Chinese president Xi Jinping and President Barack Obama.

Yet Beijing has always reneged. It is because of this past Chinese duplicity that the current negotiations have become so difficult. To guard against a repeat of such behavior, this White House demands that Beijing change its laws and that any deal include provisions allowing tariffs to snap back should China backslide. Beijing has rejected these demands, describing them as an affront to its sovereignty—something which China has always been sensitive about, but especially now with the troubles in Hong Kong.

The impasse has ignited a full-scale trade war. In late 2018, the White House placed 10 percent tariffs on an array of products coming to this country from China. The administration has threatened to up the rate on the levies to 25 percent and place them on a wider array of goods. China initially responded with similar levies on American goods coming into China. But since the United States sells China a lot less than China sells here, Beijing soon lost the ability to play the tit-for-tat tariff game with Washington, not the least because some 30 percent of the goods China imports from this country are components for its own exports, mostly of assembled computers and smartphones. Reflecting this constraint, China, in response to a recent round of White House threats, allowed the foreign exchange value of its currency, the yuan, to fall. By reducing the dollar price of Chinese goods this way, China has encouraged continued American sales by effectively relieving American buyers of the expense of the tariffs. The devaluation actually forces the Chinese sellers to bear that burden by denying them dollar amounts on sales equal to the amount the yuan has dropped and roughly to the extent that the tariffs have risen.

IN THIS standoff, the United States holds distinct economic advantages. Some 20 percent of China’s gross domestic product is tied up in exports, and fully one-quarter of China’s exports go to America, putting over 5 percent of China’s economy at risk in this trade dispute. In contrast, the United States depends on exports only for some 12 percent of its economic activity and less than 8 percent of them go to China, leaving only around 1 percent of America’s economy at risk in this matter. Not surprisingly, China’s economy has suffered a lot more than the United States’ in the dispute so far. Both foreign and Chinese firms have begun to decamp from China in order to avoid the American levies. Even the perennially upbeat and suspect Chinese government statistics admit the economic setback. In the second quarter, the most recent period for which statistics are available, they report that China’s real economy grew at its slowest rate since 1992. Export volumes have dropped some 4 percent in the past year and import volumes have fallen some 5 percent, indicating a drop in employment and consumer spending. Help wanted advertising has fallen. Ads for technology jobs have declined some 20 percent. Because of the economic hardship, China has cut back on overseas lending—so much so that flows for the first half of 2019 were one-quarter their size during the comparable time in 2017.

Though China is in a more difficult spot economically, the United States is also vulnerable. Surveys of American businesses suggest that profits have already been hampered by the added costs of the 10 percent tariffs put in place late in 2018. Firm managers say that they can cope with that extra burden, but that the threatened 25 percent tariffs would cause a good deal more harm, even though the decline of the yuan’s foreign exchange value has reduced some of the strain on American buyers. More serious are reports out of Germany that its economy has weakened, perhaps even begun to shrink. There are many reasons why it would soften, but surely a contributor is the shortfall in Chinese economic activity. China, after all, is a major buyer of German products—or at least was. Weakness in the British economy, too, may stem at least in part from weakness in China, and by extension, economies elsewhere in Asia. This weakening in Europe will redound to the detriment of U.S. economic prospects.

Effectively what is happening as a result of this trade dispute resembles in some respects what happened with the dreaded Smoot-Hawley Act. Today’s matter is less grand than in the 1930s. Trump’s tariffs impose less of a burden on fewer goods and are aimed at only one country—not the rest of the world as the Smoot-Hawley tariffs were. Nor is the U.S. economy or the world’s economy in the otherwise weakened state that typified the 1930s. But the pattern currently developing resembles that horrible historic precedent and, for what it is worth, also is what economic theory would have predicted. Moreover, the longer the impasse between the United States and China persists, the more severe these adverse economic effects will become, as weakness in one place fosters weakness in another and the troubles build on themselves.

GIVEN THE high stakes involved, it would seem only prudent for the president to stop blustering and seek a resolution with Beijing. Will he? In this regard, the odds actually are not too bad. China would clearly like to get out from under the severe economic pressure it is already suffering. To be sure, China scotched the most recent round of negotiations by stepping back from what seemed to be a willingness to meet American demands. Perhaps Beijing believed Trump would accept less than he had demanded out of a desire to announce an agreement. If so, China’s negotiators miscalculated. When, however, the Americans held firm and rejected China’s weakened proposals, Beijing’s representatives, unlike 2018 when they cut off negotiations in response to Trump’s first round of tariffs, immediately reengaged. President Xi underscored this determination to continue talks with an extremely conciliatory approach to Trump throughout all the recent tensions. The embarrassing events in Hong Kong should, if anything, provide Beijing with an added incentive to get out from under the awkward and painful effects of the dispute with Washington.

Though the sovereignty issue remains a sticking point, no doubt exacerbated by events in Hong Kong, it would seem that if the White House could work out a diplomatic formula that allows Xi and company to save face on the sovereignty matter, Beijing would willingly offer stronger assurances on this county’s three objectives. A gesture from the White House on this score might not ensure resolution, but it would make it more likely and without either side having to climb down. More importantly, it would save the world economy from the destructive effects of a major trade war.

Prospects on the rest of this administration’s trade agenda, such as it seems, are both less clear and less likely to find any resolution. Trump has singled out the EU’s use of subsidies and quotas, especially in agricultural trade, where the United States would enjoy considerable advantages. Perhaps witnessing the U.S.-China dispute will predispose Europe to a more conciliatory stance. No doubt the White House is banking on this. Likewise, perhaps Brexit and incipient tensions between Paris and Berlin will weaken the EU’s former resolve to protect agriculture, which at base is mostly a French interest. But a standoff with Europe would also likely be more difficult for the United States than the one with China, which can hardly be described as a walk in the park. Because the balance of trade between the United States and Europe is less skewed than with China, Europe would have a much greater ability than China to engage in a tit-for-tat tariff competition should the White House proceed. The distribution of economic pain would also be more even, and come to the United States earlier.

On the last and least clear part of the Trump agenda—the attack on PTAs—prospects of success are all but non-existent. If the United States were to refrain from making such “free-trade agreements,” all that would happen is that other nations would make them in the United States’ absence, isolating Washington and forcing it to engage in trade, which it can hardly avoid, as an outsider. A return to the old efforts at universal reductions in trade restrictions, if Trump really aspires to such a regime, is no longer an option. The only reason the United States succeeded between 1945 and the 1970s is because memories of Smoot-Hawley gave it an enormous will, and the results of the Second World War made it an unquestioned economic hegemon. Neither factor exists today.

Milton Ezrati is a contributing editor at The National Interest, an affiliate of the Center for the Study of Human Capital at the University at Buffalo (SUNY), and Chief Economist for Vested, the New York-based communications firm. His latest book is Thirty Tomorrows: The Next Three Decades of Globalization, Demographics, and How We Will Live.

Image: Reuters

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