Missing the Forest for the Trees on Trade

This month’s Liberty Forum essay probably should have been titled “Twenty-Five Years of Pointless Discussion on Trade.” More than anything, it shows that today’s debates over trade have not progressed since the agreement’s adoption in 1994. This is not to say that Veronique de Rugy’s analysis is merely wrong or misleading, though it does ignore any economic research that supports different or at least more nuanced positions than her own. The main problem, in my view, is that her essay attempts to treat trade as an isolated phenomenon and thus misses many of the most important issues at stake in today’s economic debates. Unfortunately, the Trump administration and other apparent targets of de Rugy’s polemic often fail to grasp these issues as well.

If we want to do more than simply replay the same tired debates for the next 25 years—while watching America continue its economic and political decline—a more comprehensive approach to the questions surrounding trade is necessary. What has been missing during the last quarter century is a thorough understanding the role of trade in the overall political economy, both of the United States and of the world.

NAFTA As the Model

The essay begins with a sober assessment of the original North American Free Trade Agreement. Its impact, as de Rugy points out, has been exaggerated by both sides. It certainly was not “the single worst deal ever,” as candidate Trump declared, nor did it bring all the benefits to the United States (or Mexico or Canada) that its promoters promised it would. For the reasons de Rugy mentions (tariff barriers were already low, other agreements were in place), the reality was “much more boring”—at least compared to China’s more problematic accession to the World Trade Organization in 2001.

Nevertheless, the “passionate” debate NAFTA provoked, and continues to inspire, is not as puzzling as she seems to think. Billed as the model of a next-generation trade agreement, NAFTA did mark a significant change in how international trade was conceived and conducted. As de Rugy points out, NAFTA “was the first major U.S. trade deal with a poor country” since the immediate aftermath of World War II. Its significance has always extended beyond its direct impacts, and the cumulative effects of U.S. trade policy after NAFTA can hardly be described as boring. This is, I suspect, why de Rugy’s own rhetoric becomes increasingly heated and ideological—and hard to square with her more measured take on the “boring” reality of NAFTA—as she moves from a specific analysis of the original agreement to a wider discussion of trade policy and the relatively minor changes included in its successor, the United States-Mexico-Canada Agreement.

Before turning to the broader debates over trade, it is worth mentioning a few items that de Rugy overlooks. First, nowhere in her article does she discuss the fact that Mexican voters seem no happier with the NAFTA status quo than many Americans. Andrés Manuel López Obrador, a leftwing “populist” who has been highly critical of NAFTA, just won the Mexican presidency in a landslide. Thus the slightly more restrictionist provisions of the USMCA cannot entirely be ascribed to the Trump administration but reflect changing attitudes beyond the United States as well.

Second, de Rugy ignores intensifying debates over investor-state dispute settlement (ISDS) provisions. NAFTA marked the first time that ISDS arbitration was included in a trade agreement between developed countries with established court systems, and these provisions have since become the norm. Whatever one’s position on ISDS, it is striking that classical liberals so often neglect to even mention the implications of ceding jurisdiction to arbitral panels unconstrained by any constitution or common law tradition. The USMCA, presumably in response to growing opposition to these provisions, limited the scope of ISDS arbitrations but did not remove them entirely.

Third, de Rugy never mentions the significant widening of U.S. trade deficits that occurred after NAFTA came into effect—and that also occurred after Chinese accession to the WTO and the coming into force, in 2012, of the United States-Korea Free Trade Agreement. It is now conventional wisdom that trade deficits don’t matter—and the accounting metric itself doesn’t. But trade deficits are inextricably bound up with things that do matter, and the fact that U.S. deficits have widened after every major recent trade agreement casts doubt upon some of de Rugy’s other claims.

U.S. Trade Policy Since 1994

De Rugy says at one point that foreigners enriched by higher U.S. imports will send their dollars back in the form of demand for more exports from the United States, prompting “U.S. producers to ramp up their production—and, hence, employment.” Obviously, however, most of these foreign dollars are not being used to buy U.S. exports, or the U.S. trade deficit would not be rising. Instead, most foreign dollars reentering the United States have gone into financial assets, which has had very different effects on employment and productivity.

De Rugy also argues that trade with low-wage countries does not disadvantage high-wage countries because workers in high-wage economies are more productive, as a result of higher capital deployment and better skilled labor in rich countries. Again, though, if this were the only factor at play, and lower wages simply equalized competitiveness by offsetting weaker productivity, then trade deficits should not be expanding. Clearly there is a lot more going on, and high-paid, high-productivity workers are not simply competing with low-paid, low-productivity workers.

The larger point de Rugy misses is that the principal effect of U.S. trade policy after NAFTA was to allow large U.S. corporations to capture greater profits by combining high-productivity technologies with low-wage labor in other countries. Outside of a few naturally “Ricardian” sectors like agriculture, the main goal of recent American trade policy has not been to expand export markets for highly productive U.S. industry. Rather, the aim has been to reduce trade barriers in order to allow multinational corporations to move highly efficient production techniques and facilities to low-wage countries and import their products back into the U.S. consumer market. The chief gains from post-NAFTA trade are precisely the proceeds from this sort of labor, regulatory, and tax arbitrage—not from U.S. export growth—which is why offshoring and U.S. trade deficits have been soaring for decades.

Where have these gains gone? Although de Rugy argues that consumer savings on cheaper imports translate into investment in the American economy (a questionable proposition),  she makes no mention of the fact that U.S. business investment has been, at best, stagnant, despite large increases in corporate profits.   In other words, most of the “gains from trade” have simply inflated asset prices in financial markets, while domestic investment and productivity growth have stagnated.

Much of de Rugy’s essay is dedicated to showing that trade (generally speaking, not just NAFTA) does not depress overall employment or wages. Her arguments along these lines might have been more compelling if she had made some effort to address recent findings—such as studies by MIT economist David Autor—that challenge this claim, or at least paint a more complex picture. But even if we stipulate that trade has no effect on overall employment or wages, there would still be serious problems with de Rugy’s arguments. The negative effects of trade policy since NAFTA came into force are not limited to the potential loss of jobs or lower wages; the main problem, in my view, is the offshoring of sectors like manufacturing that have the greatest potential to drive productivity gains, and the reallocation of workers to low value-added sectors.

De Rugy says at one point that trade creates “new and better jobs,” and cites a blog post that offers no evidence for this claim. In fact, most new jobs created in recent decades (which are increasingly part-time and precarious) have been in low-end service sectors, like food-service workers or healthcare aides, sectors notorious for low productivity. Even the share of tech-sector jobs is stagnant. Leaving aside the question of whether emptying bed pans is a “better” job than, say, working in a manufacturing plant, the fact is that the U.S. labor force has effectively been moving down the global value chain and away from sectors capable of driving productivity growth. An economy centered around a concentrated tech sector selling advertising and cheap imports to a mass of low-wage service workers, with a bloated financial sector propping up asset bubbles, is unlikely to generate significant productivity gains or maintain its competitiveness in the long term.

It is not surprising that China has become a peer competitor with, or even leapfrogged, the United States in key technologies like 5G wireless, quantum computing, and artificial intelligence. China’s largest net exports to the United States are computer and electrical components, some with critical security implications. On the other hand, America’s largest net exports to China are agricultural products and natural resources. Welcome to the “new economy”!

De Rugy seems to be under the impression that the United States is suffering from an embarrassment of trade-driven innovation and productivity growth, when in fact the opposite is true. She cites a few papers making the theoretical argument that increased competition from liberalized trade increases productivity by allowing more productive firms to expand while causing inefficient ones to exit. This logic may be correct at some level, but the simple fact is that most of the expansion and productivity growth are  occurring in places like China, while the United States has experienced two lost decades.

De Rugy does not really address any of these issues, but falls back on the misleading line that “U.S. manufacturing output is nevertheless near an all-time high.” She fails to mention that the all-time high was set in 2007, and output is barely higher today than it was in 2000, an exceptional period of prolonged stagnation. Contrary to the popular narrative which claims that the U.S. manufacturing sector is shedding jobs because of automation-driven productivity gains, the reality is that the United States lags behind much of the world in automation, and many sectors are experiencing productivity declines.

In other words, she has it exactly backwards: The transformation of the United States into a low-wage service economy is not “driven far more by technological innovation than by trade.” On the contrary, decades of economic policy favoring short-term increases in corporate profits and financial asset prices at the expense of productive domestic investment—of which trade policy is only one example—have made the U.S. economy increasingly uncompetitive and incapable of generating significant and sustainable growth.

Ideologies Versus Interests

Also ignored in her Liberty Forum essay is the connection between trade deficits and fiscal deficits. Like many libertarians, de Rugy seems totally sanguine about the former yet extremely agitated about the latter, as if the two were unrelated. But massive trade deficits must be balanced either by private-sector borrowing (such as the household borrowing prior to the financial crisis of late 2007 through 2009) or government borrowing. De Rugy appears oblivious to the fact that the policy agenda she supports has actually created a global economic situation in which the U.S. economy can only grow through widening deficits. And her response to government deficits—brutal austerity—would make everyone poorer while doing little to address declining U.S. competitiveness or the structural issues behind the current global financial and economic imbalances.

Meanwhile, the Trump administration seems to have accepted the libertarian approach to taxes and regulation while adding tariffs and jettisoning any concerns about deficits. Unfortunately, scattershot tariffs unconnected to any comprehensive national economic strategy might disrupt problematic trade arrangements but won’t improve them. As a consequence, the Trump tax cuts have stimulated a lot of share buybacks but are unlikely to incentivize the investments needed to revive U.S. competitiveness and long-term growth prospects. The heightened uncertainty sown by this administration’s actions is likely to hamper that revival as well.

Many on the Left clearly understand the weaknesses of the above approaches, but tend to focus exclusively on distributional issues rather than developing a coherent, state-led program for national growth and development. After a certain point, their redistributionism, pursued in the absence of  productivity gains, could well put us on track for the stagflation of the 1970s.

In short, America’s economic problems will not be solved by another NAFTA or another tariff or another tax cut. What is required is a new international political settlement, on the scale of Bretton Woods, to address global imbalances, along with new domestic political settlements on issues such as monopolies, financialization, wealth-distribution, and social insurance. Accomplishing any of that, however, requires treating economic policy as a matter of national interest rather than an ideological exercise. Essays like “Twenty-five Years of NAFTA” suggest that this is still a long way off, and the persistence of anemic economic performance and increasingly chaotic politics seems far more likely.

Reader Discussion

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on January 09, 2019 at 12:26:10 pm

This essay is based upon bad economics.

The conventional wisdom is the trade deficit doesn't matter.

But then, it goes on to make all sorts of errors regarding trade deficits.

The trade deficit with anyone country is irrelevant. It is completely harmless to buy products from firms in one country and pay for them by selling products in some other country. Any notion that there is a problem unless Mexico buys as much from the U.S. as the U.S. buys from Mexico is irrational. Foolish. And this essay expresses that concern.

The overall trade deficit is a different matter, but it isn't caused by these country-by-country issues. Rather it is a matter of an imbalance between national saving and investment. More is spent on capital goods in the U.S. that can be funded by U.S. saving. Roughly, the result of a trade deficit is the U.S. produces fewer of the goods and services being imported and also produces fewer goods for export but instead produces more capital goods that remain here in the U.S. (if they were sent to another country they are an export.)

A foolish way to reduce a trade deficit is to discourage investment. Increased national saving, especially by a reduced budget deficit, would reduce the trade deficit, and that would not be harmful or foolish.

But the notion that imports from "poor" countries cause trade deficits and that limits on those imports will reduce the trade deficit is mistaken. For the most part, the result would simply be shift of trade deficits to richer countries. The U.S. would have a larger trade deficit with Germany or Japan.

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Bill Woolsey
on January 09, 2019 at 14:11:45 pm

Perceptive observations (out of necessity touching only lightly on a selection of pertinent issues) and combined with reasoned analysis. A refreshing read that reinforces my optimism that somewhere real efforts are being made on the behalf of the public.

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David Bouwman
on January 09, 2019 at 16:11:04 pm

Julius Krein’s response here to my colleague Veronique de Rugy’s “Twenty-Five Years of NAFTA” is such a flood of fallacies and half-truths that it’s impossible in a short space even to list - and much less to refute - them all. So I’ll focus on some of the most significant flaws.

First, after expressing agreement with what he calls the “conventional wisdom” that “trade deficits don’t matter,” Krein writes as though they do matter. Krein is simply mistaken to assert that “trade deficits must be balanced either by private-sector borrowing (such as the household borrowing prior to the financial crisis of late 2007 through 2009) or government borrowing.” Foreign holdings of dollars add to the U.S. trade deficit, yet no borrowing is involved. Ditto for purchases by foreigners of American real-estate or foreigners’ creation on American soil of businesses. And therefore Krein is incorrect to assert that the policy of free trade that Ms. de Rugy supports has “created a global economic situation in which the U.S. economy can only grow through widening deficits.”

Second, Krein’s labeling as “misleading” Ms. de Rugy’s report that U.S. manufacturing output is today near an all-time high is itself misleading - and highly so. While Krein’s observation that the all-time high for U.S. manufacturing output was reached in 2007 is correct - and while his claim that this output is “barely higher today than it was in 2000” is defensible (But just barely: is eight percent higher “barely higher”?) - Krein conjures a mistaken impression of a stagnant U.S. manufacturing sector only by forgetting to tell his readers that manufacturing output fell during the recession of 2001 and again during the recession of 2007-09. Apart from these dips - which occur during all recessions - U.S. manufacturing output has long been, and continues to be, on a pretty steady trajectory upward. It is today 45 percent higher than it was when NAFTA first took effect and continues to rise. Furthermore, U.S. industrial capacity has risen consistently since NAFTA took effect (as it had for many years before), and is today at an all-time high and 66 percent greater than it was when NAFTA was launched.

Finally, Krein credulously repeats the unwarranted if commonplace assertion that economically we Americans and our “competitiveness” are “declining.” Yet just last month in the Washington Post Robert Samuelson reported evidence that debunks the stagnation myth. And as for our “competitiveness” - a term, by the way, that has far less meaning than people such as Krein suppose - U.S. exports hit an all-time high this past April (before declining a bit because of Trump’s trade war). U.S. exports are today, in real terms, 200 percent higher than they were when NAFTA commenced.

Again, a host of other flaws infect Krein’s essay. But the ones mentioned above should be sufficient to reveal that his case against Ms. de Rugy’s analysis is superficial and groundless.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

P.S. For links to the data that I mention above, please go here: https://cafehayek.com/2019/01/veronique-correct-critic-not.html

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Donald Boudreaux
on January 09, 2019 at 20:29:18 pm

It is refreshing to see a real world analysis of the managed trade regime so jealously guarded by the rent-seekers employed to promote it. I live in Hong Kong and have for the past 25 years, a period in which I have watched China get rich and highly competitive as America has retreated into gated communities of wealth surrounded by a sprawling class of the economically disenfranchised. The American "free trade" model of privileging asset owners at the expense of wage earners has been great for urban housing values and the consumption costs of their owners, but it is painting the country into a privileged corner. Manufacturing capacity attracts design skills which attracts R&D investment, all of which are most efficient when located near the ultimate source of demand - that's not the NY area or San Francisco. So the sooner this topic is freed from the hired elites who seek to own it, the better off for the country as a whole.

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on January 09, 2019 at 20:36:42 pm

The reason the USA has a trade deficit is not because we have an imbalance between savings and investment. It is because chronic surplus countries like China, Germany, Japan et al. have artificially forced up savings, and they then export those extra savings--along with their unemployment--to unwitting deficit countries like the USA that ought to know better.

Discouraging investment is exactly what we need to be doing--as counterintuitive as that sounds. The problem in the USA is the lack of productive investment opportunities--opportunities that will generate more actual GDP.

To generate that, we need to increase demand by moving more dollars to the working class. That will reduce savings and increase consumption. Demand will generate its own supply!

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Warren Platts
on April 26, 2019 at 05:24:09 am

the Trump administration and other apparent targets of de Rugy’s polemic often fail to grasp these issues as well.

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Law & Liberty welcomes civil and lively discussion of its articles. Abusive comments will not be tolerated. We reserve the right to delete comments - or ban users - without notification or explanation.