Is Faith in Free Trade Misplaced?

Jeff Madrick, a senior fellow with the Century Foundation, in “Our Misplaced Faith in Free Trade,” an October 3, 2014 opinion column for the New York Times notes:

Trade is one of the few areas on which mainstream economists firmly agree: More is better. …

But then Madrick reports polls showing public skepticism about the benefits of freer trade, and writes:

Free trade creates winners and losers — and American workers have been among the losers. Free trade has been a major (but not the only) factor behind the erosion in wages and job security among American workers. It has created tremendous prosperity — but mostly for those at the top.

These claims that “free trade” was a major source to U.S. wage and job security “erosion”, and growing income inequality, is discussed below.

Madrick claims there are key flaws with “mainstream” economic models:

Since the 1970s, economic orthodoxy has argued for low tariffs, free capital flows, elimination of industrial subsidies, deregulation of labor markets, balanced budgets and low inflation. This philosophy — later known as the Washington Consensus — was the basis of advice the International Monetary Fund and the World Bank gave to developing countries in return for financial help.

Madrick is his 2009 book, The Case for Big Government claims there are key flaws with “mainstream” economic models. This January 2009 New York Time review, written in the aftermath of the 2008 financial crisis, begins:

In his first Inaugural Address in 1981, Ronald Reagan asserted, “Government is not the solution to our problem; government is the problem.” In his 1996 State of the Union speech, Bill Clinton acknowledged, “The era of big government is over.” But when Barack Obama takes office he is much more likely to call for great national endeavors than to condemn the government that makes such projects possible. …

Madrick’s book makes a case for more federal spending and increased regulation:

“The Case for Big Government” shows how yesterday’s contrarianism can become today’s consensus. A leading economist, a former financial columnist for The Times and an adviser to Senator Edward Kennedy, Jeff Madrick makes the case that the nation faces social and economic challenges requiring higher taxes, increased public investment and more rigorous regulation of corporate conduct. 

It is understandable that scholars hold divergent views of what is wrong with the U.S. economy, and disagree about what policy changes could address economic problems. The U.S. economy, like every other economy in the world, is mixed, with major sectors run, subsidized, and regulated by state and federal governments, and major sectors left relatively open and coordinated by private enterprises. The healthcare and finance sectors, for example, have long been among the most heavily regulated in the U.S. economy. So when either or both sectors malfunction, it is an open question whether the private firms or government regulators are to blame.

I would agree, drawing from the NYT title, that “faith” in free trade is misplaced. Instead, people should understand the actual principles and realities of markets and international trade. People should understand the reason behind dynamic market forces and gains from increasing the scope and scale of international trade.

Madrick includes the claim (above) that:

 Since the 1970s, economic orthodoxy has argued for low tariffs, free capital flows, elimination of industrial subsidies, deregulation of labor markets, balanced budgets and low inflation.

Actually, economic orthodoxy has argued for these reforms since the 1770s: since the publication of Adam Smith’s The Wealth of Nations in 1776. Smith explained why it is reasonable to import from other countries goods produced less expensively overseas. People in England and Scotland ought to devote their scarce land, labor, and capital producing goods that, thanks to climate, natural resources, and local skills, they can produce less expensively. Some of these goods can then be exported in exchange for goods from other countries. Low tariffs (which are taxes on imported goods) encourage division of labor and specialization, increasing the gains from trade.

Subsidies for domestic industries not only burdens taxpayers, but also reduces specialization, keeping labor and capital in less competitive industries, preventing them from shifting to industries better able to compete in world markets.

In Adam Smith’s time, labor markets were tightly regulated by guilds that restricted entry into most professions. Deregulating labor markets encouraged people to discover and develop their natural skills and move to where they could earn the most, rather than stay restricted to professions they were born into or granted entry by friends and relatives.

Madrick writes (above):

Free trade creates winners and losers — and American workers have been among the losers. Free trade has been a major (but not the only) factor behind the erosion in wages and job security among American workers.

This could be stated another way: freedom has costs and “creates winners and losers.” When we are free to spend our money the way we choose, some people and companies benefit and others don’t. Every day in the marketplaces, some companies “win” when consumers choose their products, and others “lose” when consumers pass them by. Free trade is just extends this choice and competition across borders, to include goods and services produced in other countries.

Farmers in Washington state farms “lose” when consumers purchase fruits and vegetables grown in Oregon and California. Farmers in the U.S. “lose” when food is purchased from producers in Mexico, Chile or China. However, Washington state orchard owners and workers gain from exports to other states and countries of Washington-grown apples, pears, peaches, cherries and other crops.

U.S. producers and employees benefit from selling their goods and services to customers around the world. The over one billion consumers in China have attracted a lot of interest from U.S. companies. At the same time, goods and services produced in China and imported to the U.S. expand choices for consumers here, but also increase competition for U.S. producers of similar goods and services.

Is Madrick’s claim, that “American workers have been among the losers” from freer trade supported? Well, that claim is part of a larger debate over income statistics. Contrasting videos from economists Robert Reich and Don Boudreaux make divergent claims about the causes of unequal incomes. which I discuss in this post on last year’s NCFCA LD debate topic.

A problem with the claim that average incomes in the U.S. have stagnated or fallen over the last couple decades is that they obviously haven’t for most people. Most people earn higher incomes as they gain job skills, and that’s been the case for most in the U.S. over the last twenty to thirty years.

However, it can be true both that average or median incomes have fallen over thirty years and that most people earn more now than they did twenty or thirty years ago. Many earn less, of course, as millions have retired or died over the last thirty years, but most earn more. It seems a bit of a mystery, but is explained by immigration and women joining the workforce.

I encourage readers to watch at least the beginning of the Bill Moyer’s video with Robert Reich linked above to get a sense of his claims of growing income inequality (which, in turn, Madrick in his NYT article, blames on freer trade).

Here is George Mason University economist Don Boudreaux’s five-minute response to a Robert Reich YouTube video making similar claims:

Washington state’s population was 4.1 million in 1980, but is now 7 million. Median (middle) household income in 2013 was $57, 554 (pdf) and in 1989 was $31,183. So median income is up a lot in Washington. But so are housing expenses. Houses on average are much bigger than they were in 1990, but also much, much more expensive. Clothes are generally less expensive, thanks to imports from China and other developing economies.

But here is a key, since the 1980s economic development has varied significantly across the United States, much as it has in countries around the world. Tax and regulatory policies are part of the reason, as are trade policies around the world.

This three-minute Learn Liberty video by economists Josh Hall, “Economic Freedom and Growth,”explains why economic prosperity visits some places and not others:

Hall contrasts the economic prosperity of South Korea, with its open economy, with the closed economy of North Korea and its impoverished population. And from the annual Economic Freedom of North America report,  Hall also contrasts the lack of economic growth in high-tax West Virginia with neighboring Maryland, where taxes are lower.

Companies and jobs have migrated to Maryland, and similar company and employment migration has accelerated over the last decade. This 2015 Heritage Foundation study, 1,000 People a Day: Why Red States Are Getting Richer and Blue States Poorer. Employment and average income is has risen in states with lower taxes and less labor regulation that have attracted foreign automobile makers like BMW, Mercedes, Volkswagen, Toyota, Honda, Nissan, and others to build out large new manufacturing plants across mostly southern states.

Relative income and manufacture jobs fell since the 1980s in older and higher-taxed northern states like Michigan, Illinois and Ohio, which were  for years called the “Rust Belt.” Some of these manufacturing jobs “moved” to southern states, as consumers purchased cars built by “foreign” car companies and assembled there. Other jobs “moved” further south to Mexico where many U.S. and international firms now manufacture parts and assemble automobiles.

So manufacturing jobs in some states declined and in others expanded. And huge number of manufacturing jobs in all developed countries were replaced by new technologies that allowed automating repetitive tasks.

So… sorry if this discussing is taking too long. But I hope readers can see that the debate over a “misplaced faith”turns on where one stands and where one looks for evidence of progress or decline.  Plus, across the U.S., millions of immigrants started work at U.S. firms at wages well below average. Their pay was better in the U.S. than in Mexico and other countries they immigrated from, but their low wages reduced average wages in the U.S. economy. So even if income for most U.S.-born workers increased, average wages were down as immigrant wages were added to the bottom.

The view from China is one of astonishing progress. China’s population has grown by nearly 400 million people since 1980 (from 987 million to 1.38 billion). Chinese families in 1980s, when market reforms were launched, survived with an average household income of under $300. Chinese leaders could see the stunning economic growth of neighboring Japan, Hong Kong, Taiwan, South Korea, and Singapore. Leaders knew they needed to open their economy to markets and international trade and investment (Chinese leaders, visiting Japan and Hong Kong in the 1970s, joked that if Chinese women learned how everyday women dressed outside China, the government would lose power instantly).

Since then market reforms began in China in the 1980s incomes have risen Arrival Cities in China, and Globalization at the Crossroads, noted, hundreds of millions have migrated to China’s cities, and the migration continues.
dramatically, lifting hundreds of millions out of abject poverty. There is a major divide in China between rural and urban incomes, but as an earlier post,

World Bank Gross National Income per person in China has risen steadily, from $1,750 in 2005 to $4,300 in 2010, to $7,380 in 2014. So the view if open markets and trade is a positive one for a billion plus people in China. Economic progress has been similarly rapid since the 1980s for people in Taiwan and South Korea. And though the data is debated, most Americans are much better off, though significantly older, than in the 1980s.

I discussed the rapid economic development of China in this 2007 post, Instant Cities and the Rise of China, and update here (pdf).