Free Trade Is No Utopia

(Bloomberg Opinion) -- President Donald Trump recently suggested the removal of all tariffs and non-tariff barriers to global trade. Sounds intriguing, but free trade is rare and it's certainly no utopia. 

Historically, it’s been largely confined to periods when a major global power promoted the free exchange of products in its own enlightened self-interest. That was true of Great Britain in the 19th century after it spearheaded the Industrial Revolution and wanted to insure the easy flow of raw materials for its factories from abroad and foreign markets for their output. After World War II, Americans used trade to rebuild Western Europe and Japan to counter the Soviets, and accepted the lack of reciprocity by some of those lands, notably Japan. This was cheaper and more acceptable in the Cold War era than garrisoning more American troops around the world and risking more military confrontations.  

The classical foreign-trade theory espoused by English economist David Ricardo (1773-1823) held that unfettered trade made all trading partners richer. To Ricardo, even if one country is more competitive in every area than its trading partners, that nation should concentrate on the areas in which it has a competitive advantage, leading to mutual benefits accruing to all economies involved. He used the example of English-produced wool being traded for French wine.

Subsequently, economists noted that Ricardo’s simple trade model requires economies in static equilibrium with full employment and neither trade surpluses nor deficits, and similar living standards. These aren’t true in the real world. Also, Ricardo didn’t consider countries at different stages of economic development and different degrees of economic and political freedom, or exchange-rate manipulations and competitive devaluations since gold was universal money in his day.

Ricardo also didn’t factor in trading partners with huge wage differences, such as exists between the U.S. and China. China can produce almost any manufactured good cheaper than America, which has a competitive advantage in almost nothing. The result has been huge and chronic U.S. trade and current-account deficits. Last year, the U.S. trade deficit grew 12 percent to $566 billion, the largest since 2008.

Completely free trade is unlikely because countries have vastly different economies in different stages of development, different degrees of domestic economic and political freedoms and separate currencies. To achieve free trade, governments would have to reverse much of the involvement in their economies and financial markets they’ve gained since the 1930s. They’d have to surrender considerable sovereignty to market forces and could no longer keep out imports in the name of health and safety, either to support local industry or due to true civic concerns. Where is the dividing line between imported recreational marijuana and narcotics? Completely free trade would also require completely free-floating currencies with no government interference. It's hard to imagine politicians giving up all that control.

Still, what would this unlikely utopian world look like? It would probably be more cyclical without government actions to redress trade imbalances. In the absence of devaluations, currency controls and other stabilizing techniques, trade deficits would accumulate in weak countries. Their currencies would collapse as foreign investors and locals fled and depleted foreign-exchange reserves. It cost China $1 trillion to accommodate a capital flight in 2014. Political revolutions would be more frequent and international relations strained as the strong get stronger and the weak get weaker.

Without China’s demand for technology transfer as the price for American firms doing business there and outright theft of U.S. technology, the American trade and current-account deficits would shrink. More production and profits for Americans would benefit the U.S. economy, but that current-account deficit provides the liquidity the rest of the world needs to finance growth, and its shrinkage is highly deflationary.

Globalization would probably persist due to the continuing vast differences in the cost of production between developed and developing countries. Even as Chinese incomes rise, India, soon to overtake China as the world's most populous country, has a huge supply of unemployed and underemployed cheap labor. Ditto other Asian lands.

American consumers would benefit from continuing cheap imports from low-cost countries, including goods from Asia and legal, accounting and other services from India. Americans with the skills and knowledge to compete in a free market world would continue to thrive, but the rest would suffer lower incomes as globalization wiped out more service jobs as well as manufacturing positions. 

In agriculture, U.S. grain producers would gain from unrestricted exports to developed and developing economies. Rice exports would lock out expensive domestic rice from Japan, where that grain is still considered sacred and imports are severely limited. American farmers would benefit as European governments are forced to remove GMO restraints on grain and meat imports. Wisconsin dairy farmers could export freely to Canada. Canadian maple syrup would decimate Vermont’s output and free sugar imports would wipe out American producers of cane and beet sugar that are now protected by import quotas. As a result, the domestic price is 30 cents pound, compared with 11 cents on the world market. Unrestrained Canadian timber imports would squeeze American producers.

The dollar would be stronger as a haven in a volatile currency world. There would be no currency manipulation to contain the greenback.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

A. Gary Shilling is president of A. Gary Shilling & Co., a New Jersey consultancy, and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.”

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