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The Rise of American Protectionism
The wedge issue of the 2016 primary campaign is the rising hostility to free trade—and, specifically, to the Trans-Pacific Partnership. On the Republican side, establishment candidates like Jeb Bush, Scott Walker, and Marco Rubio have failed or fallen behind, while Donald Trump maintains a commanding lead going into Florida and Ohio thanks, in large part, to his protectionist rhetoric. On the Democratic side, Hillary Clinton has been veering leftward to fight off a determined challenge from Vermont’s democratic socialist Bernie Sanders, another unapologetic protectionist.
There are of course major difference between the insidious Trump and buffoonish Sanders. The former, for example, favors low taxes and the latter confiscatory ones. Still, the real selling point of each boils down to one issue: In the indecorous language of the pollster, Pat Caddell, Americans feel “they have been screwed” by free trade. Caddell writes as if this virulent falsehood is an undisputed fact. What is undisputed, however, is that Adam Smith’s defense of free trade is in retreat as protectionism becomes the common thread across the both political parties. It is as though the economic unwisdom of the 1930 Smoot-Hawley Tariff Act is back. The question is why protectionism is having a political moment.
One answer is that things have not gone well in the United States. Standards of living have been static at best, and people feel economically insecure. In this environment, it is easy to blame the obvious culprits, like the tide of imports and the systematic movement of American jobs overseas to locations where the regulatory environment is more favorable and where the cost of labor is cheaper.
But putting the story in this fashion conceals the key benefit of free trade. Free trade offers an uncompromising indictment of, and a powerful corrective for, America’s unsound economic policies. Private investors have been voting with their feet in response to such policies. Simply put, the reason that local businesses outsource from the United States is the same reason why foreign businesses are reluctant to expand operations here. Our regulatory and labor environment is hostile to economic growth and there are no signs of that abating anytime soon. The United States has slipped to eleventh place on the Heritage Organization’s 2016 Index of Economic Freedom. And it is not just because other nations have moved up. It is also because the steady decline in freedom and productivity inside the United States has continued apace. Ironically, the strong likelihood that the next American president will expand protectionist practices will only make matters worse: firms, both foreign and domestic, are more reluctant to invest in the United States, and the risk of a trade war by other countries such as Mexico is a live possibility, especially if Trump imposes high tariffs on automobiles made there for the American market.
The great advantage of a free trade policy is that it both reduces these political risks and makes it impossible to conceal these glaring structural defects from the world. And once they are recognized at home, free trade gives the federal government and the individual states strong incentives to clean up their act so that they can once again be attractive to foreign investment. There is, moreover, only one way for that cleanup to proceed. The United States must reduce the drag that its regulations impose on all businesses that operate within its borders, which means rooting out the various forms of monopoly power, like unions, that can only survive if protected by state law.
This point explains why the American labor movement has historically opposed free trade. The essence of unionism is, and always will be, the acquisition of monopoly power. There is no way for a union to obtain that monopoly power in the marketplace. It can only secure it through legislation. The first step in that process was the exemption of unions from the antitrust laws under Section 6 of the Clayton Act of 1914. The second major step was the legitimation of collective bargaining under the National Labor Relations Act of 1935, which gave the union the exclusive bargaining rights against the firm once it was successful in a union election. These major statutory benefits strengthened private sector unions and imposed inefficiencies on unionized firms. This, in turn, opened the field for new firms, like the Japanese automobile companies, to organize outside the union envelope. In response, labor’s strategy went one step further. It pushed hard on trade and tariff barriers to keep out foreign imports, and exerted political influence to encourage local zoning boards to exclude new businesses that do not use union labor. Add to these issues the aggressive rise of minimum wage laws and other mandates like Obamacare and family leave statutes, and you construct a regulatory fortress that defeats the corrective forces of free trade and renders the nation less economically resilient and productive than before.
It is easy to say that people are “screwed” by free trade if you only look at the stories of those individuals who lose their jobs. It is much more difficult to make that case after taking into account the simple but powerful truth that overall levels of profitability and wealth increase under free trade. The short-term relief that targeted groups get from protectionist measures mask the larger inefficiencies that slow down the rate of growth. Despite what the Democrats think, transfer programs are no substitute for growth. Indeed, the imposition of new taxes without return benefits on the firms taxed only depresses the rate of return on investment further, which will necessarily compound the problem.
There is, however, a powerful way to see that free trade in international markets is not the villain. It is to look at trade and the competition for business between states. This point was missed by Time’s trade writer Rana Foroohar. She starts off correctly by noting that globalization and free trade do increase global wealth and prosperity. But she then adds this unwise caveat: “But they have also increased the wealth divide within countries, in part because these forces created concentrated groups of economic losers in specific parts of our country,” including the Midwestern Rust Belt, which gave Trump and Sanders the opening to power themselves to their recent victories in Michigan.
On this last point, Foroohar’s narrative goes badly astray. The Rust Belt states have been hit hard because they have been badly governed. They lose much of their business to other states that are better governed. Just look at the internal migration of people and businesses across state lines within the United States—changes that cannot be attributed to the supposedly malevolent influence of foreign trade on domestic trade. It can, however, be attributed to differences in the business climate across the states. The careful study by the Small Business Enterprise Council reveals a marked difference between low-ranking states like California (50), New Jersey (49), and New York (45) and high-ranking ones like South Dakota (1), Nevada (2), and Texas (3). It is wrong to dismiss these key differences, and to think that the decline in badly governed states is but a foretaste of what will happen across the board if free trade is allowed to run its course.
These population shifts matter. Before California turned leftward, it was a magnet that drew huge numbers of people from New York into its borders. Now, it is places like Texas that are experiencing population growth. States like Illinois, New Jersey, and New York, all of which are under fierce financial pressure, are also the victims of outward migration. When it comes to the loss of manufacturing jobs—a big symbolic issue for people like Trump and Sanders—it is states like Illinois, as the Illinois Policy Center reminds us, that consistently lose out to Indiana, Michigan, and Wisconsin, which have recently repealed their right-to-work laws, and which have sharply lower workers’ compensation rates. Strong union pressures block intelligent internal reform as the economic bleeding continues.
At this point, it is necessary to clarify once again the economic case for competition: The interplay of market forces tends to lead to the most efficient allocation of scarce resources. The creation of a monopoly raises prices over marginal costs by blocking beneficial trades, reducing firm formation, and diminishing innovation. The forces of competition are relentless in that they let no individual keep a lock on their current economic position. But that is exactly as it should be. American agriculture has long suffered on the view that farmers are entitled to guaranteed prices for their crops no matter what the conditions of supply and demand may be. The imposition of rent control and rent stabilization in certain key real estate markets like New York City drives up the costs of housing, including for people from outside the city who have no voice in local politics. The parties whose rights are vested celebrate the stability that government regulation brings into their lives. But they blissfully ignore the higher rates of uncertainty that their actions place on others who have fewer market opportunities for housing and jobs now that the incumbents have sewn up their protected positions.
The great challenge in this area is to ask whether there is some way to cushion the blow when the various legal protections are no longer made available to groups that have come to rely on them. Some people argue that displaced workers should receive job training programs or cash payments to ease their transition. But the former never work, and there is sensible resistance to the latter. And we never engage in these programs for loss of jobs from one state to another. There is, indeed, a third way to deal with this problem, which is not to assume that low rates of growth are a fixed fact of nature when they need not be. The best protection for the displaced tenant and worker is an open economy that offers multiple options for new housing and new jobs. But that won’t happen so long as we have national, state, and local policies that are protectionist to the core.
There you have it. The great bipartisan tragedy of the 2016 election is that Trump and Sanders want to double-down on the failed policies that have brought us to our current impasse. So long as economic discourse is controlled by economic know-nothings, prospects for economic improvement will remain bleak.
© 2016 by the Board of Trustees of Leland Stanford Junior University
Published in Economics, Law
US is a state and he was referring to laws that states pass as he always does. If you’ve read him you know he certainly does not recommend more Federal regulation.
In the case of China, their trade advantage is cheap labor for sweatshop jobs. We used to have sweatshop jobs here. We drove them out, by regulating the minimum wage and work place conditions. At the time we did that, the cheap labor was being provided by Japan and smaller Asian countries. Now Japan has raised its standard of living and the cheap labor is in China. But even if there was no China, we wouldn’t have those jobs.
Now it is true that China has required American companies like GM to build cars in China if GM wants to sell cars in China. Just like the US required Toyota to build cars in the US if it wanted to sell cars in the US. That’s pretty typical, and that is the kind of regulation that these trade deals try to limit. In the absence of trade deals you don’t get less government meddling in the market; you get more government meddling.
I should also mention, for the benefit of anyone who likes the trade-off of getting more jobs in exchange for lower wages and higher prices, that you can accomplish the same result without the inefficiencies of getting the government involved in picking winners and losers, simply by allowing high inflation. Or, to use a different term, by devaluing the dollar. (Inflation and devaluation are two terms for the exact same thing.) That would lower American wages in real terms, lower the American standard of living, and make our goods more competitive in world markets.
Me, I don’t particularly want to engage in a race to the bottom with China. I’ve seen the standard of living in China personally, and even if we could beat them at the game of producing cheap goods with really underpaid labor, I wouldn’t want to. But if that’s the kind of thing that appeals to you, then Jimmy Carter is your favorite President.
That’s the process that’s occurring. I agree with that. I agree there are benefits. The question is whether the benefits are a net plus for Americans on a broad scale and not just for some.
Plus I don’t think we required Toyota to build a plant on the US. It turned out economically beneficial to do so.
The Clinton Administration threatened 100% tariffs on Japanese cars. That forced Toyota to agree to manufacture in the US. That agreement is one of the “trade deals” that people are now complaining about.
http://www.nytimes.com/1995/05/17/business/sanctions-japan-overview-100-tariffs-set-13-top-models-japanese-cars.html
All of the trade deals we have negotiated in recent decades have had the effect of forcing open foreign markets to US goods, when the foreign country was already freely selling their own goods in the US market. These deals have been good, good, good for us, and have created jobs in the US rather than shipping them overseas. The Toyota deal was a good example of that.
The Chinese market is dominated by cars ranging from crappy knockoffs of western cars to cars built by Chinese-controlled JVs, all at prices well above what a tariff-free western import would go for. QED.
I meant to emphasize 3, but the other two are relevant.
One of the famous cases of piracy by a Chinese JV partner was Chery’s (ignore the trademark infringement of Chevy) copying of GM’s products that were based on cars GM made/sold in Korea.
Also, Chinese size preferences for cars tend to not mirror Japanese. That plus resentment over the occupation was why I emphasized US and Europe. That being said, I can easily see a situation where a Japanese, European, or American company made US & China models in the US. Consider that Buick is a US/China product.
Many problems with that analysis. Consider the economic concept of “comparative advantage”. Also consider quality issues and other costs (such as machinery, communicating between engineers and manufacturing, etc.). In general, the conclusions you are implying are disproven by the fact that China needs to impose trade barriers.
To the detriment of other countries. This is a “prisoners’ dilemma” situation in economics.
That depends on what you are comparing to. It also begs the question of timing.
You are comparing to a world where there are massive trade barriers on the JP side and none on ours. You are not comparing to a truer free trade situation.
You are also discussing a situation where Japanese trade barriers had already let them build an industry that could then outcompete ours. China has not gotten there yet. We can take a different approach with China aimed at preventing them from reaching the point where they can outcompete us.
Utterly false.
China effectively bans all imports of both cars and parts with confiscatory tarrifs. Large numbers of Japanese-made cars and parts are sold in the US.
China does not merely require manufacture by the foreign entity in China. They require that the foreign entity let a Chinese company control a JV to do the manufacture.
China does not merely require that the JV do the manufacture. They require the foreign entity to transfer engineering knowhow to the joint venturer to then let the joint venturer compete with the foreign entity.
That’s what a good trade deal would try to limit. But that’s why we need someone who will negotiate good trade deals.
The problem with free trade is that you can always find dirt cheap disposable workers somewhere. You cannot compete with the Third World in terms of dirt cheap labor. This doesn’t bother Larry too much – after all, his job is to keep labor costs down. His job is safe.
Free trade is not a magic wand. It’s a tool to advance your economy. We should be using it to get access into closed markets and not always saying yes. Every American policy, including trade policy, should be aimed at improving America.
I’ll read more then. I realize that the term “state” can be used in two ways, but there is such a constant beating of drums to use federal power to remove state regulation these days, whether in fantasy football or labeling of GMO foods, that I assumed he was yet another of those who is trying to do away with state-level regulations.
Well, I certainly appreciate the gratuitous, ad hominem observation about my motives. Oddly, I don’t recall us having met, so your intimate knowledge of my job duties and my philosophy is a little bit surprising.
Just for the record, it doesn’t matter a bit whether I or anyone else am “bothered” by economic laws, any more than it matters whether I am “bothered” by gravity. Gravity is going to exist, whether it “bothers” me or not.
Except that, if we stick to the analogy, the money you’re spending on your grocer, dry cleaner, and mortgage is only 6% of your overall income, going by the graph.
http://nypost.com/2016/03/12/how-democrats-abandoned-the-working-class-and-spurred-rise-to-donald-trump/
You’re doing the Lord’s work Larry. Don’t listen to the h8ers.
“Excluding oil, the United States actually has a trade surplus in manufactured goods (you read that right) with the 20 countries with which it has trade agreements (although that does not include China).”
Source.
My problem with China is they are one of the biggest Human right violators in the world. They still have capital punish for people preaching and trying to educate people about their Religion. Why we give a Fascist nation Preferred trade status is beyond me. Basically we selling people out to get more of the all mighty dollar.
Wait a second. To use hypothetical numbers: It may have created 5,000 jobs, but the rest of the auto manufacturing has lost 75,000 jobs. Is that a net plus? Where did all the auto manufacturing jobs go?
And, if we forced Toyota with tariffs, doesn’t that substantiate Trump’s position that we haven’t negotiated these things properly? Did it cause the next great depression? It didn’t.
Scrooge.
How else would you negotiate this?
Isn’t the point of the WTO (please somebody correct me) to facilitate trade (which is good) by removing non-tarrif barriers?
Another snake handler.
Well, since your hypothetical numbers are just your hypothetical, I suppose the answer is “you tell me.” But if auto manufacturing jobs have been lost, my guess would be that they were lost to technology, and to the fact that the big three American auto companies are now in the business of providing health insurance for current and retired UAW members, and produce cars as a sideline.
[Edit: Just to explain that a bit, until they went bankrupt in circa 2008, their business model was along the lines of the old Johnny Carson joke: “We lose money on every sale. How do we do it? Volume!” They cut back on production because for some odd reason, that business model wasn’t working very well.]
Well, I can’t find the figures. I do find it hard to believe that the net auto jobs lost were strictly from technology. But I don’t know. I’ve always been a free trader. I’m just questioning the validity behind the theory. I haven’t found either side make a convincing case.
You described them in other threads, Larry. I pay attention. Fortunately, we have not met, but I can judge based on your postings here. I am glad you appreciated my attack. Please let me know if you would like further ad hominem attacks, particularly if you have a favorite type of attack you would prefer.
I haven’t gone out researching it either, but you would certainly expect the American auto makers to downsize after being bankrupt or nearly bankrupt, and we know they have. GM, for example, eliminated its Oldsmobile and Pontiac divisions. That’s going to cost some jobs, but not because they went to China.
Fair enough. I’m an engineer. We try to design a process with the least labor. I know where that’s at. Still it’s notable – though I agree not necessarily a causation – that since 2000 when the trade deals fully started to take effect, American salaries in real terms have stagnated.
Several errors.
First, a significant factor in the weakness of American car manufacturers is the loss of foreign markets to trade barriers.
Oldsmobile was killed well before the bankruptcy due to redundancy with Buick (returning to that later). Hummer, Saturn, Pontiac, and nearly GMC were killed for various reasons including pure politics.
This all coincided with the transformation of Buick into a Chinese-focused brand that would principally build cars in China via Chinese-controlled JV. “SAIC-GM was the top passenger vehicle producer in China in 2006, with sales of 413,400 vehicles. In 2011, SAIC-GM sold 1,200,355 vehicles in the Chinese market.” That seems hugely causal. But you also need to consider that SAIC leveraged the JVs to then produce even more cars under its own name. Absent the barriers, all those sales, not just those of the JV would have gone to foreign companies.
It’s not true that income has stagnated. If you look at consumption numbers, rather than “median wages” (as the lefties always do) you will see that the standard of living is steadily rising for all classes. And that’s without even taking into account technological innovation that gives even lower income people goods and devices that would have been unheard of a decade or two ago.
Here’s what’s wrong with looking at the median wage. First, it does not account for low skill, low income people (especially illegal aliens) entering the population. That brings down the median dramatically. Second, it does not account for individuals raising their standard of living over time. People do climb the ladder, even if the ladder itself doesn’t move. Third, it does not account for transfer payments. A lot of the purchasing power in this country derives from government hand outs, but government benefits are not counted in calculating median wage. Nor are the taxes imposed on those who are above the median counted as a reduction in their income.
If you want to measure people’s standard of living in real terms, look at purchasing power (consumption).
Manny, I should add that since 2000 there have been economic events which have had a much larger impact than any trade deals. Two major shocks to the economy – the bursting of the .com bubble in 2000 and the bursting of the housing bubble in 2008. Loads of ridiculous regulations imposed, like Dodd-Frank. Tax increases. The rise of terrorism as a major threat. Obama’s catastrophic foreign policy. As you acknowledged, correlation does not establish causation.
ctlaw,
You seem to be obsessed with the fact that GM (voluntarily!) entered the Chinese market by the avenue of a joint venture. I have to admit, I don’t get it. So what? If GM decided to abstain from the Chinese market entirely, rather than enter a joint venture, how would American workers be better off?
Sure, I would prefer that China allowed our goods to freely compete in their markets. But I recognize that China is still a largely socialist, centrally-planned economy. It is moving in the right direction, but slowly. What we need is a trade deal with China, getting them to open up their markets. Instead, we get reflexive opposition to trade deals in this country, and support for starting a trade war that will put the world’s largest consumer market even further out of our reach.
I mean, hell, why don’t we just go ahead and nuke them? Sure, it might cost us a few cities in their retaliation, but that seems like a small price to pay for expressing our justified disapproval of their trade policy.
You just make these pronouncements, without a shred of support. How do you know that absent the barriers, China wouldn’t have built its own cars for domestic consumption, just as they always have, and just as the Soviets did? You speak as if American companies had some sort of divine right to monopoly control over markets in foreign countries.
Sure, if China built its own cars on its own, they would be lousy cars for quite a while. I don’t think that would bother the People’s Politburo a bit if the alternative was surrendering their entire market to foreign companies.