Magazine | September 12, 2016, Issue

Four Myths about Trade

True free trade is still optimal, but its advocates are stuck in the 20th century

The content and tenor of debate in this presidential-election season has Washington’s pro-trade establishment in a panic, wondering what has happened to the previous consensus about the merits of global economic integration. Yet rather than question their long-held assumptions, establishmentarians have concluded that the problem must be with the American people and the political demagogues leading them astray. The less charitable among them dismiss opponents as “less educated” isolationists, nationalists, or ethnocentrists. The more charitable assume that if trade supporters would just slow down and enunciate clearly — Trade is good! — then maybe the unwashed would get the message.

But what if it’s the experts who are wrong, not the voters? Could it be that establishmentarians are stuck in the 20th century, while voters have moved on to the 21st? As my colleague Stephen Ezell and I wrote in our book Innovation Economics: The Race for Global Advantage, most in the Washington policy establishment share a deeply held view about trade and globalization that is grounded in four key assumptions, all of which came to be accepted in the post–World War II period, when the United States was the world’s dominant economic power. None are open to serious question in elite circles, but the truth is that they all are outdated, and that we must achieve a more accurate understanding of trade if we hope to defend and promote it in a compelling way.

The first assumption is that America is the world’s economic leader because it is the most open, entrepreneurial, and market-driven economy. The idea is that we will prosper if we open our economy to the world because we will be dealing with economies that are unable to be as competitive. But the reality is that while the U.S. economy retains many of the strengths it built up in the post-war era, other countries have caught up in numerous areas by developing their own strengths. In fact, the United States now runs the largest trade deficit of any nation in history. Meanwhile, according to the Heritage Foundation, the United States is not even in the top ten when it comes to economic freedom. And America ranks even lower when it comes to entrepreneurship, according to the Global Entrepreneurship Monitor.

The Washington trade establishment’s second core belief is that trade is an unalloyed good, even if other nations engage in mercantilism. Willem Buiter, a Cambridge University economist and a former head of the European Bank for Reconstruction and Development, spoke for many in the trade establishment when he wrote in a 2003 letter to the editor of the Financial Times: “Remember: unilateral trade liberalization is not a ‘concession’ or a ‘sacrifice’ that one should be compensated for. It is an act of enlightened self-interest. Reciprocal trade liberalization enhances the gains, but is not necessary for the gains to be present.” In other words, it doesn’t matter if other nations massively subsidize their exporters, require U.S. companies to hand over the keys to their technology in exchange for market access, or engage in other forms of mercantilist behavior. As one congressional-subcommittee chairman replied when asked whether China’s mercantilism hurts the U.S. economy, “Adam Smith proved that mercantilists only hurt themselves.”

Because the establishment believes trade is good under even the most lopsided of circumstances, it sees the issue in black-and-white terms. There are only two camps: free-traders and protectionists. And confronting foreign protectionists risks making us protectionists. Better to embrace free trade and let other countries be mercantilists, the establishment argues, than to engage in a “trade war.” America should show misguided nations by force of example, rather than prosecution before international bodies, why mercantilism is bad. But China and others are proving that this is folly. In industry after industry, including the advanced innovation-based industries that are America’s future, they are gaming the rules of global trade to hold others back while they leap forward.

To be clear, reciprocal free trade between two nations is the optimal condition, as both of the trading nations and the global economy will benefit. But one-sided trade (with nations that are mercantilists) has not produced net gains for the U.S. economy over the last 15 years. Therefore, having the United States push back on mercantilist nations by limiting trade with them, particularly as a tactic to pressure them to roll back their mercantilist policies, would be in our interest. Limiting trade would definitely not be in our interest if applied to nations that generally abide by the global trading rules (such as Canada and Mexico, for example).

Third, the Washington trade establishment clings to the doctrine of “comparative advantage.” First postulated by 19th-century economist David Ricardo, the theory holds that nations have natural advantages in certain goods (e.g., the English in textiles and the Portuguese in wine) and each does better when it specializes in these industries. A corollary is that whatever an economy produces is determined by the market and therefore optimal, unless it is distorted by economic policy. Thus, the United States has evolved to be a big producer and exporter of wastepaper because we have a comparative advantage in garbage, and any attempt to change that would be suboptimal. This implies that any industrial structure that results from trade, even if it is mercantilist trade, is optimal. Lest you doubt that many in the establishment believe this, consider that when the head of a leading pro-trade think tank was asked how much manufacturing we could lose to foreign competitors and still be okay, his response was “All of it.”

But today this doctrine is flawed for two reasons. First, most trade is not in goods and services based on national endowments, such as arable land, energy supplies, and raw materials, as it was in the pre-WWII era. Most is in goods and services based on specific technological capabilities and business advantages, none of which are unique to any particular nation, but all of which are affected by good or bad economic policies. Second, exporting large amounts of waste while at the same time running a trade deficit in high-tech goods (in excess of $100 billion a year) is not a reflection of our particular comparative advantage. It’s a reflection of having lost competitive advantage to other nations in many higher-value-added industries, in part because of foreign mercantilist policies and domestic economic-policy failures.

However, establishmentarians know that voters have a different view, which is why they go to Herculean lengths to deny that the country’s losses in manufacturing have been due to trade. They can’t very well dispute the fact that between 2000 and 2011 America lost one-third of its manufacturing jobs, including jobs in high-tech manufacturing. But they blame the loss on technology-driven productivity. Council on Foreign Relations scholar Roland Stephen echoes this view when he writes that “manufacturing’s productivity gains allowed output to rise while employment fell.”

But this is misleading because, as Brookings economists Martin Baily and Barry Bosworth write, manufacturing-output growth “is largely due to the spectacular performance of one subsector of manufacturing: computers and electronics.” In other words, because of Moore’s Law — the doubling of the number of transistors on a chip every 18 to 24 months — and the unique way the U.S. government measures output in the industry (unlike other nations, which measure chips and computers, the U.S. government measures transistors), productivity in this sector grew a phenomenal 800 percent in this period, compared with around 30 percent for the rest of manufacturing. Indeed, as the Information Technology and Innovation Foundation (ITIF), of which I am president, has written, this sector, which accounted for 8 percent of manufacturing jobs in 2000, contributed 120 percent of U.S. manufacturing-output growth in the 2000s. Output in the rest of manufacturing actually declined, something that had never happened in the post-war period. ITIF estimates that, when this and other factors are accounted for, about two-thirds of manufacturing jobs were lost to trade.

To be sure, technological innovation, like trade, can displace jobs. But unlike technology, which raises GDP and increases wages, foreign mercantilism acts to reduce both of these. This gets to the last and most important tenet of the establishment’s trade doctrine: Because the United States leads the global economy, because mercantilists hurt only themselves, and because our current industrial structure is always optimal or close to it, the economy as a whole must benefit from trade even though some individuals may be hurt. But as Tufts professor Daniel Drezner writes, “even if the aggregate gains have massively outweighed the losses, it’s hard to deny that trade has wreaked some serious carnage on some parts of the American economy.”

It follows that the only correct solution is to give more help to the victims of trade and hope they will stop complaining. For the Washington trade establishment, there is nothing wrong that can’t be fixed by expanding Trade Adjustment Assistance, the federal program that helps workers hurt by trade. Do that, and most Americans will be back on the trade bus.

But reality is not as neat and tidy as this 20th-century model. The truth is that if we are to have any hope of succeeding in the 21st-century global economy and turning popular sentiment away from protectionism, our leaders will have to offer up more than just the fig leaf of adjustment assistance or the false narrative that it’s technology’s fault.

Rather, the trade establishment needs to confront two core problems that keep America from fully benefiting from 21st-century globalization. The first is that many nations do not play by the official rules of global trade, as enacted largely by the World Trade Organization; they engage in a host of unfair mercantilist practices, including intellectual-property theft, forced technology transfer, local-production requirements, currency manipulation, unfair subsidies, standards manipulation, and more.

It is naïve and wrong to believe that one-sided free trade (with the United States being free and many of its competitors being mercantilist) will lead to an increase in global economic welfare (certainly relative to free trade but also relative to reduced trade with mercantilist nations), much less U.S. economic welfare. It is true that mercantilists often hurt themselves, but they almost always hurt the U.S. and global economies, too. So it is incumbent upon the U.S. government to vigilantly enforce trade rules, such as by bringing many more trade-enforcement cases to the WTO, pressuring global aid organizations to cut funding to mercantilist nations, limiting the ability of companies in mercantilist nations to buy U.S. firms, and more. Congress should give the next administration greater resources and an express mandate to do so.

The second problem stems from the fact that when the trade consensus was first formed, the U.S. economy was so dominant that hardly anyone could imagine the country might need a competitiveness strategy. Today we are far from dominant.

It’s sheer fantasy to think that most firms in America will necessarily win if we simply open up more markets. Some firms will do well, but without a robust national competitiveness strategy, many won’t. Those who favor trade should be first in line calling on Congress to put such a strategy in place. It must begin with reducing the effective tax rate on corporations. To believe that America can thrive in the global economy with the world’s highest statutory corporate-tax rates and among the highest effective corporate-tax rates, especially for manufacturers, is to ignore the intense global competitive realities of the 21st century. Tax reform then needs to be complemented with two other key items: a regulatory-reform strategy particularly aimed at reducing burdens on industries that compete globally, and increased funding for programs that help exporters, such as the Export-Import Bank, the new National Network for Manufacturing Innovation, and a robust apprenticeship program for manufacturing workers.

It’s clear that even if we enforce trade rules more vigorously and enact a national competitiveness strategy, opposition to trade will not vanish. Some on the left will continue to reject globalization because they long for an economy sheltered from global competition in which labor unions can more easily obtain uncompetitive wages and regulators can impose their will with impunity. Likewise, some on the nativist Right will continue to want as little as possible to do with the rest of the world. But most voters are more pragmatic than that, so it’s likely that if Congress and the next administration develop a credible new globalization doctrine for the 21st century — melding tough trade enforcement with a robust national competitiveness agenda — then necessary trade-opening steps like the Trans-Pacific Partnership will once again be on the table and the U.S. economy will begin to thrive once again.

– Mr. Atkinson is the president of the Information Technology and Innovation Foundation.

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