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Defending Free Trade

Its costs have been exaggerated and its benefits neglected.

11:00 PM, Feb 25, 2009 • By DUNCAN CURRIE
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Even before Wall Street imploded and the U.S. economy sunk deeper into a nasty recession, Americans were souring on free trade. In recent months, the backlash against globalization has been exacerbated by rising unemployment and a sense of economic crisis. During the 2008 campaign, Barack Obama railed against free trade as he and Hillary Clinton tussled over primary votes in Rust Belt states such as Ohio and Pennsylvania. Now Obama has an opportunity to embrace a more responsible position and display true presidential leadership on a critically important issue.

Unfortunately, the economic stimulus plan he signed last week contains a "Buy American" provision that U.S. trading partners have fiercely opposed. The controversial clause says that all public works projects funded by the stimulus must use American-made iron, steel, and manufactured goods. In an attempt to placate anxious foreign officials, U.S. lawmakers required that the "Buy American" plank be "applied in a manner consistent with U.S. obligations under international agreements."

Of course, even if the United States does not violate its World Trade Organization (WTO) obligations, the "Buy American" language could still spark a damaging trade fight. Writing in a New York Times online forum, Columbia economist Jagdish Bhagwati said it was "naive" to think the "WTO-consistency qualifier" would be sufficient to forestall retaliatory actions. He predicted that "countries like Brazil, China, and India" would respond in kind. If they did, Bhagwati added, we would be looking at "a WTO-consistent trade war."

Treasury chief Timothy Geithner didn't help matters when, in a written statement to the Senate Finance Committee during his confirmation process, he announced that "President Obama--backed by the conclusions of a broad range of economists--believes that China is manipulating its currency." This fueled speculation that the Obama administration would pressure Beijing to boost the value of the yuan and make the U.S. dollar relatively weaker. Meanwhile, foreign governments are worried that America's subsidies to its troubled domestic auto industry "could lead to distortion and protectionism" (in the words of German chancellor Angela Merkel).

On the campaign trail, Obama pledged to "renegotiate" the North American Free Trade Agreement (NAFTA) if elected. When asked about NAFTA at his press conference last week with Canadian prime minister Stephen Harper, Obama mentioned the perils of protectionism but also expressed his hope that U.S. and Canadians officials could find a way to add new labor and environmental provisions to the trade accord. During his time in the Senate, Obama opposed bilateral free trade deals with Colombia, Panama, and South Korea, all of which were signed by the Bush administration and still await congressional approval. Obama has yet to clarify how he will handle these trade pacts as president. In mid-January, New York Democrat Charlie Rangel, chair of the House panel that oversees trade, signaled that Obama "wants to work with Republicans and Democrats to get those trade agreements moving," according to Reuters. Congressional Democrats blocked the Colombia, Panama, and South Korea accords while George W. Bush was in office. Though House speaker Nancy Pelosi and other leading Democrats may prove more flexible under President Obama, they will be wary of riling organized labor.

Free trade is easy to demagogue even in good economic times, let alone during a harsh recession. Americans often exaggerate the costs of trade liberalization and neglect its benefits. In a 2005 New York Fed study, economists Erica Groshen, Bart Hobijn, and Margaret McConnell found that "trade has only modestly affected aggregate U.S. employment." More specifically, "Through year-end 2003, the number of jobs embodied in net imports did not exceed 2.4 percent of the country's total employment."

Foreign competition has certainly affected the U.S. manufacturing sector, but so has technology. As American Enterprise Institute economist Philip Levy has noted, "The long-term decline of American manufacturing jobs has much more to do with technological change than with trade. We're producing more stuff with fewer workers." Economists Martin Baily of the Brookings Institution and Robert Lawrence of Harvard have calculated that between 2000 and 2003, trade was responsible for "only 11 percent of the total manufacturing job loss."

In their 2005 study, Groshen, Hobijn, and McConnell discussed how free trade encourages "specialization" among individual countries and thereby reduces the cost of producing goods and services. "Specialization makes trading partners richer because each exchanges goods it produces efficiently for goods that its partners can produce at lower cost," they wrote. As Cato Institute trade expert Daniel Griswold explained in a 2007 report, "Trade is not about more jobs or fewer jobs, but about better jobs." It has made the U.S. economy and U.S. workers more productive. While trade competition causes job displacement, "the number of people dislocated from their jobs each year because of shifting trade patterns is relatively small in America's dynamic market economy where 'job churn' is a normal, healthy fact of life."

What about China and its undervalued currency? Economists Christian Broda and John Romalis of the University of Chicago's Booth School of Business argue that Chinese exports have provided a significant boost to low-income American consumers. Broda and Romalis estimate that between 1994 and 2005, U.S. trade with China "helped reduce the relative price index of the poor by around 0.3 percentage points per year. This effect alone can offset around 30 percent of the rise in official inequality we have seen over this period." They reckon that "while the expansion of trade with low-wage countries triggers a fall in relative wages for the unskilled in the U.S., it also leads to a fall in the price of goods that are heavily consumed by the poor," and "this beneficial price effect can potentially more than offset the standard negative relative wage effect."

Swiss National Bank economists Raphael Auer and Andreas Fischer recently examined how cheap imports from nine low-income countries--Brazil, China, India, Indonesia, Malaysia, Mexico, the Philippines, Thailand, and Vietnam--have affected the U.S. Producer Price Index (PPI) inflation rate. Auer and Fischer concluded that "from 1997 to 2006, imports from [the nine] low-income countries reduced the U.S. PPI inflation rate in the manufacturing sector by about two percentage points (each year). China accounts for over half of the total effect."

The U.S. manufacturing sector is currently hemorrhaging jobs, but so are manufacturing sectors around the world, due to the sharp drop in global demand. As the dismal economic news has accumulated, the temptation to turn protectionist has grown. The international community needs America to offer a robust defense of free trade. Too bad that, as Jagdish Bhagwati told me, "We are failing to provide the leadership."

Duncan Currie is managing editor of the American.