Everyone Knows Free Trade But What About New Trade?
In 2012, I attended a symposium on trade at Tsinghua University in Beijing, China, during which among other subjects, globalization, free trade and China’s growth were discussed. Interestingly, during a question and answer session, a Chinese professor, who shall remain nameless, but identified himself as from Peking University, said: “Developed countries, including the U.S.A. were once underdeveloped. Mercantilism allowed them to become developed. Now that they are developed, they want to push free trade on the rest of the world. Why should China heed this call?”
At the time, there were three experts on the stage answering questions. Not one of them could offer an answer addressing the why.
The reality is he was right. Number one, It is true developed countries used mercantilism in order to build their economies. Number two, China is not the only country doing it. There are many others.
However, what the professor was missing is given China's size, predatory trading practices, and intellectual property right violations, it would be a matter of time, before the Middle Kingdom would face push-back from the US and other developed countries.
As it turns out, we are finally seeing substantial push-back from not just the US, but also from some countries in Europe and Asia.
Traditionally members of the Republican Party have been proponents of a Laissez-Faire approach to markets promoting unrestricted trade. Democrats, on the other hand have been more interested in partnering with unions and labor in order to protect jobs. However, the last two democratic presidents have been very willing to create free trade agreements those unions, labor and progressives within the Democratic Party have claimed cause damage to the U.S. economy.
Today this distinction between free-traders and those that view this past national policy with skepticism, is somewhat blurring. While business leaders are still pushing for unfettered access to America’s markets to continue as well as their ability to ship jobs abroad upon demand, some Democrats and Trump’s supporters want limits put on imports.
Some economists laud the benefits of free trade. They claim it is beneficial for a country to engage in international trade even when it imports products it is able to produce for itself. They claim that international trade allows a country to specialize in the manufacture and export of product it can produce efficiently, while importing those they are less efficient in producing.
They claim this process brings down prices at home, giving consumers more money to spend in other products. This, ultimately being beneficial to the overall economy. Consequently, the poor and the middle class benefit as they are able to buy products they would normally not be able to afford.
There are also geopolitical reasons for free trade. As I have mentioned in my article Understanding International Trade and Why Trump's Approach is Misguided, there have been many instances in which the US as well as other countries have entered into free trade agreements (FTA), mostly for security reasons. The charts below, show all the FTAs in which we have entered since President Reagan. In each case, a compelling argument can be made that each country and region involved have been of crucial geostrategic importance to the US.
The TPP is one particular case that stands out for its importance as President Obama attempted to reassert U.S.A.’s influence in the Pacific Rim over increased Chinese ascendancy and pressure.
Globalization and Free Trade
Globalization and free trade are to a great extent, concepts that are dependant on each other. The tendency of globalization is for businesses, technologies and cultures to spread throughout the world. Whether your view of globalization is more in line with the social-cultural dimensions of globalization, or whether you are in line with industry that sees globalization as a business opportunity, the fact is that the world is becoming ever more interconnected.
In the meantime, do we continue to blindly trust the Milton Friedmans of the world who claim that international trade should be totally free? Those business and political leaders who spouse this philosophy want no import duties, quotas, anti-dumping regulations or any other restriction on trade.
However, there are other economists such as Dr. Paul Krugman and Dr. Kamal Monnoo, (there are many more ) that don’t quite agree with this assertion.
As Dr. Monnoo wrote: Modern day thinking being that while expanding global markets is a worthy goal, history offers lessons that only fair and ‘constructive trade’ is what nations should be seeking — ‘constructive’ referring to a realization that only such trade is welcome that materially adds value to the home economy and ensures a gradual but clear development of its core national industries. (Dr Kamal Monnoo — March 2016)
Could a rich country be worse off with free trade? The economist Paul Samuelson said that the dynamic gains from trade may not always be beneficial, saying free trade may ultimately result in lower wages in the rich countries. One of the many reasons being that the ability to off-shore service jobs that were traditionally not internationally mobile could have a similar effect to that of a mass inward migration into the U.S., where wages would then fall.
To his point, we have seen in recent years the rise of medical service jobs, such as X-rays and M.R.I. scans being sent electronically to other countries, mainly India, for analysis and diagnostics. The savings that a hospital or a physician's group can accrue from this type of off-shoring of medical analytical service is substantial. In the meantime, high paying professional jobs are stripped away.
All this leads to the question if not free trade, is there another option?
New Trade AKA Smart Trade
Some politicians have called it smart trade; while some other trade experts point to what they call strategic trade. In international trade parlance similar policies are called “New Trade.” Irrespective of what it is called, or how it is framed, the fact is that unfettered trade, just like its darker brother, mercantilism, is an extreme approach that needs further scrutiny.
New trade theory suggests that the ability of firms to gain economies of scale (unit cost reductions associated with a large-scale output) can have important implications for international trade and for the local economy. New trade theorists argue that using protectionist measures to build up certain industries, will allow those sectors to dominate the world market.
This is particularly important for infant industries (new industries) which later can allow countries to begin a path to specialization and control over global segments. This model can create the national specialization of industries, as we have seen in Japan with auto manufacturing, Hollywood with film making, Switzerland with watch making and many more.
These economies of scale can outweigh the more traditional theory of comparative advantage. In essence if a country specializes in a particular industry then it may gain economies of scale in that industry allowing for global dominance. This is especially important for firms who have the advantage of being an early entrant as they can become a dominant firm in the market.
Based on the assertion above, we can say that new trade theory suggests that governments have a role to play in promoting new industries and supporting the growth of key industries through strategic planning and investment.
A tactical approach in the usage of tariffs, subsidies and laws that prevent corporations from outsourcing crucial technologies could be needed to achieve the goal of economies of scale locally. (T. Pettinger — 2013)
Most people will probably agree that in today’s globalized market place, mercantilism or protectionism is not going to work. Technological advances, transportation, population growth and the desire for world peace and harmony will not accommodate a trade theory based on isolation and 16th century notions of exporting to colonies.
Trade wars in which the extensive use of tariffs is used, are bound to fail, since inflation rises, retail output decreases and stock markets suffer. Additionally, tariffs can be easily countervailed by the exporting country through currency devaluation.
Something else to consider is that raising tariff on a country, will only invite local and American manufacturers to move their productions to other low cost manufacturing nations. That production rarely, if ever, return to the US, since this would imply rebuilding costly manufacturing capacity that has already left this country long ago. Not to mention, once prices establish themselves at lower levels, consumers will reject increases.
Possible Strategies for a New Trade National Policy
The following strategies are often used by other countries as a way of staying engaged in global trade but at the same time protecting and helping to grow industries of national importance.
- Help infant industries, especially those that are in cutting edge technologies, create economies of scale that would allow the US to be dominant in those world segments. This could be accomplished through government investment in research and development (R&D), tax penalties for off-shoring manufacturing, non-tariff barriers placed on foreign competition and low but strategic tariffs on foreign competitors.
- Investment for firms facing global competition can help industries of national importance develop foreign markets as well as protect their domestic markets.
- Create tax or subsidy incentives for companies seeking first-mover advantage in domestic or international markets. The goal being to allow the domestic company to gain economies of scale in order to gain dominance in global markets.
- Enter into bilateral and multilateral free trade agreements that take into consideration global security issues and allow for low technology, low-cost consumer products to be off-shored or imported from foreign manufacturers.
- Create benefits for factory employees displaced due to outsourcing. Benefits to last up to three years and paying 80% of their previous salary. Provide these employees with education and training programs and health insurance benefits.
- Create tax distinctions between foreign direct investments and off-shoring of manufacturing. Incentives should be created for companies that develop foreign markets and not for those that merely manufacture overseas in order to sell their products in domestic markets.
- Invest in R&D and technology development that would eventually be channeled to production in the US.
- Heavily invest in alternative energy, with the purpose of not only battling climate change, but also with the goal in mind of becoming a dominant producer and exporter of clean energy equipment and technology.
These are but a few of the ideas the US should be looking into in order to stay competitive globally and avoid unnecessary and damaging trade wars.