Ian Fletcher (email him) is an Adjunct Fellow at the San Francisco office of U.S. Business and Industry Council, a Washington think tank. An economist with impeccable academic and private sector pedigrees—Columbia, University of Chicago, hedge funds, private equity groups—he is refreshingly, perhaps uniquely, skeptical of his profession. "We can't trust the economists", he writes, adding that while the public holds the economics profession in highest regard, "What economists say to the public is often very different from what they say to one another"
Fletcher has written an elegant, easy-to-read critique of one of the most cherished myths in economic theory—the supremacy of free trade. (Free Trade Doesn't Work: What Should Replace It and Why,
Fletcher believes that our chronic trade crisis stems from bad policies that mainstream economists told us were OK.
He is hardly the first to say this. Debunking free trade dogma has become a cottage industry in America, employing journalists, retired CEOs, and even a few economists whose paycheck does not come from a corporate beneficiary of free trade. But few bring Fletcher's historical, psychological, and economic insights to this undertaking. (One hopes he will follow the free trade book with one on immigration or sub-prime mortgages.)
The theory of free trade originated with David Ricardo, a British economist of the early nineteenth century. He believed in two interrelated concepts: specialization and comparative advantage. According to Ricardo, each country should produce only those goods in which it excels—i.e. can make with comparatively less labor and capital than its trading partners—and import everything else. The theory implies that an advanced economy, say the United States, should import some goods from lower cost producers, say China, in order to free up our workforce to produce more valuable goods instead.
Advocates claim free trade is the natural state of affairs: Left to their own devices capitalists will achieve this international reallocation of production automatically. Their natural drive for profit steers them to the most valuable industry. Any policy other than free trade just saddles them with higher costs and fewer profits than they would otherwise incur.
But the public is blissfully unaware of the degree to which this theory full of holes. Enter Fletcher. He shines a laser beam on the unrealistic assumptions, dubious conclusions, and changing circumstances which, taken together, undermine the received free trade dogma.
In several chapters Fletcher lists and explains the fallacies underlying free trade. My selective, slightly modified version:
Immobile Capital: In Ricardo's world countries exported goods for which they best suited based on their "natural endowments" of land, climate, capital, and expertise. For eighteenth century Britain, with its superior human and physical capital, this meant exporting manufactured goods and textiles. Portugal, with a warm climate and an abundance of unskilled labor, had a comparative advantage in wine and agricultural products.
But back then a country's natural endowments were immutable; neither capital nor labor moved internationally. Not today: U.S. corporations have invested about $3.2 trillion in China alone, and added another $340 billion in 2009, while hundreds of thousands of Chinese workers have been educated in U.S. colleges and universities.
Absolute advantage. The offshoring of U.S. capital to low-wage countries has nothing to do with comparative advantage. U.S. companies are not seeking comparative advantage at home in order to compete abroad. They are seeking absolute advantage in cheap foreign labor, with which to dominate markets at home and abroad. With U.S. capital, foreign workers are now as productive as Americans, the difference being that the large excess supply of labor that overhangs labor markets in China and India keeps wages low. Labor that is equally productive but paid a fraction of the wage is a magnet for Western capital and technology. Meanwhile, capital exports have destroyed entire industries, occupations, and communities in the U.S.
Winners and losers. Ricardo and his acolytes assume workers displaced by cheap imports can easily move to expanding industries. Don't have the requisite skills? More education and on the job training will take care of that. In the long run Ricardo believed a free economy has a natural self correcting tendency to return to full employment.
Fletcher agrees—up to a point:
"Sometimes the difficulty of reallocating workers shows up as unemployment…But in the U.S., because of our low minimum wage and hire-and-fire labor laws, this problem tends to take the form of underemployment. This is a decline in the quality rather than the quantity of jobs. So $28 an hour ex-autoworkers go work at the video rental store for eight dollars an hour. Or they are forced into part time unemployment: it is no accident that, as of September 2009, the average private sector work week had fallen to 33 hours, the lowest since records began in 1964."
Bottom line: the "tendency" to full employment under free trade is enforced by permanently lower income.
Misreading economic history. Before Adam Smith and Ricardo there was mercantilism—which Fletcher calls a "misguided" regime of gold accumulation through exports. Only after Britain embraced free trade in the 19th century did she become an industrial superpower. At least that is the free trade party line.
Reality check: British industrialization was underway for three centuries prior to 1776, the result of a primitive industrial policy that included import taxes and prohibiting the export of raw materials to foreign producers. Even as late as the early 19th century trade was not as free as the free traders would have us think: Britain's average tariff on manufactured goods was about 50%—the highest of any major European country, according to Fletcher.
Free trade began in earnest with the repeal of the Corn Laws in 1846. A disaster ensued: "Competition with the prairies of North America eventually devastated Britain's old rural economy and the aristocracy that had lived off its agricultural rents, but so committed was Britain to free trade that this price was accepted as in no other nation."
Meanwhile, on the other side of the pond, American industry flourished behind a wall of protective tariffs. Around 1880 Britain was surpassed economically by the U.S.
Ideologues and mathematicians - Fletcher contends that many free trade supporters are simply Ayn Rand cultists (think Alan Greenspan) or libertarian ideologues like Milton Friedman, whose reflexive aversion to Social Security, Medicare, the postal service, public education, and welfare are often mistaken for economics.
As for non-political economists, the theoretical models they use to describe comparative advantage do not admit the possibility of unemployment. It's not that they do not think unemployment is possible. Rather, no one has figured out how to allow for it in the confines of a simple mathematical model.
Significantly, Fletcher notes that economists who specialize in trade issues are much less sanguine about the benefits of free trade than"…their brethren in other subspecialties who cling to what they remember from their grad-student days."
Trade deficits self-correct – For decades trade deficits have lowered U.S. GDP and reduced the value of the dollar abroad. Both of these trends should, in theory, reduce America's ability to buy foreign goods. Yet the deficit persists.
The problem, of course, is that mercantilism is alive and well in China, Japan. They are our enablers—happy to sustain our spending binge by buying dollar-denominated assets, keeping our interest rates low, and reducing costs for U.S. companies who locate within their borders.
Bur eventually the party will end. The dollar will lose its status and U.S. offshorers will return home. Had a tariff been in place from the outset, those job losses would have never occurred.
Fletcher would like to see free trade replaced with across-the-board 30% tariffs for all goods and services. He sees this as working selectively to help retain "infant industries" employing considerable capital and likely to benefit from considerable scale economies, but not enough to bring back the apparel industry which employs large numbers of unskilled workers.
But Fletcher does not discuss how tariffs would work if exchange rates are not fixed, as they were (to gold) in the golden age of American protectionism in the nineteenth century—a question that VDARE.COM editor Peter Brimelow raised in his American Spectator review of Pat Buchanan's The Great Betrayal
Additionally, and certainly to the disappointment of VDARE.COM readers, Fletcher says almost nothing about immigration. Yet both give corporate America access to cheap foreign labor; both harm native-born workers.
Fletcher notes that "withdrawing from free trade (to an as yet undefined extent) is emerging as the consensus Democratic response, even if the party's leadership doesn't yet realize how deep are the forces driving this or how far it is likely to go" whereas "the emerging Republican response seems to be keeping free trade while opposing immigration—which does not enlarge America's shrinking economic pie, but does cut it into fewer slices per voter and is therefore politically salable."
But while there may prove to be some truth in this analysis, the fact is that no Republican in Congress has yet signed on to an anti-unemployment immigration moratorium.
Still, perhaps against my professional interest as an economist, I have to say I respect Fletcher's book. At the end of the day, he is merely proposing that American's economy be run for the benefit of the American people.
This is a radical, and definitely interesting, idea.
Edwin S. Rubenstein (email him) is President of ESR Research Economic Consultants in Indianapolis.
