IMPOVERISHED BY FREE TRADE

The Bottom Eighty Per Cent

From its establishment in 1788-89 until the final quarter of the twentieth century, the United States was known around the world as a good place for the working man. America long suffered from a shortage of labor to run its rapidly growing economy and high wages drew millions of workers as immigrants to the United States over that period.

Since the mid 1970s, however, the picture has changed dramatically. Adjusted for inflation, male hourly wages have declined every year over the past forty two years while female wage increases have not been nearly enough to offset the impact of the lower male earnings. Thus, overall median household income declined with the middle class falling from 61 percent of the population in 1971 to 50 percent in 2021 according to that year’s Census report.

In the fifty two years since 1970, the income of the bottom 80 percent of the U.S population has risen less than one percent annually. Only the top 20 percent has seen a significant rise in income and even they have managed an increase of less than two percent annually. Only the top five percent have made out as well in this period as the average income earner of the 1940-1975 period did.

So what happened after 1975, you ask. I can answer in one word - globalization.

Economists, bankers, U.S. political leaders, top journalists, leading commentators, big business CEOs, and foreign policy experts were united in the view that free trade, untrammeled international capital flows, and global technology transfer could only create more wealth for all Americans as well as for the rest of the world. On top of that, globalization would, they said, inevitably result not only in rising global wealth but in global democratization.

How could so many smart, highly educated people be wrong? It became the style. To obtain a professorship at any leading university, one needed to confess this doctrine. To become a top journalist, high level official, corporate leader, or to receive an invitation to the annual Davos or Bilderberg Group meetings it was de rigueur to profess this faith. Nor, if you were in the top 5 percent, or better yet, the top 1 percent of the income distribution, was it difficult to do so because you were doing extremely well as were all your friends and the people who lived in your gated community.

Still, it should not have taken the rise of Communist China to something like economic and technological equality with the United States, or a global pandemic and a collapse of global supply chains to awake our leaders to the realities of globalization.

Historically, Adam Smith was an early booster of free trade as part of his thinking about how the unseen hand of the market optimizes economic activity. However, the first theoretical argument for free trade was that of British banker David Ricardo in 1817. He used the example of Britain and Portugal making wine and cloth. His model worked under the assumption that Britain was less good at producing both commodities than Portugal but that it was less bad in making cloth than in making wine. He then demonstrated that both countries would be better off if Portugal specialized in only making wine while Britain focused only on making cloth. By trading Portuguese wine for British cloth, both countries would came out ahead in Ricardo’s calculations. This concept became known as comparative advantage. It is perhaps most easily understood by using the example of a surgeon who is also a better typist than her secretary. Both she and the secretary are better off if she sticks to surgery and allows the secretary to do the typing.

This concept was further elaborated in the 1930s by the Swedish economists Eli Hecksher and Bertil Ohlin who added the notion that a country’s endowments of land, labor, and capital play a key role in what it makes, imports, and exports.

In the wake of WWII, the international economy was structured on the basis of these free trade concepts with the International Monetary Fund (IMF) and the General Agreement on Tariffs and Trade (GATT) as the twin pillars of the system.

For the United States, the period from 1945 to 1975 was the golden age of its economy which grew faster, paid higher wages, generated more profits, and developed more new technology than ever before, and, indeed, than had any economy in history. One reason was that it had virtually no competition as Europe and Asia struggled to recover from the war. Another was that the war had stimulated enormous advances in technology that were now generating rapid growth of the consumer led economy.

By the early 1970s, however, the scene was beginning to change rapidly. Europe, especially Germany, and Asia, especially Japan, had not only recovered but with newer factories and currencies still fixed at the now ridiculous (because their productivity had increased dramatically since 1945) levels first set in 1948, were taking global markets away from U.S. corporations and even beginning deeply to penetrate U.S. markets - think Volkswagen or Sony.

In 1972, President Richard Nixon took the dollar off its long standing gold standard (1 troy ounce of gold =$35) and allowed its value to be determined entirely by the open currency markets. He did this because the century long U.S. trade surplus was beginning to go into deficit and a river of gold was flowing from Fort Knox to U.S. trade partners in Europe and Asia.

But, this move worked only insofar as it halted the flow of the gold river. It did not bring back the trade surplus. Indeed, 1975 was the last year in which the U.S. accumulated a surplus. Since then U.S. trade has been in chronic and ever growing deficit. This year, 2022, the deficit will likely top $1 trillion for the first time. This means that Americans will have bought from abroad $1 trillion more than they sold abroad. It means that a trillion dollars worth of jobs were created or sustained abroad while more than 20 percent of the working age population of the United States did not have a job.

In theory, this deficit and unemployment rate should not exist. Exchange rates should adjust to raise prices of U.S. imports and reduce those of U.S. exports. But that has not happened, and it hasn’t happened for a lot of reasons, but the major one is that the free trade doctrine has long been based on a lot of false assumptions.

For instance, the theory assumes constant full employment, no costs related to starting up or shutting down an enterprise, perfect competition (no player has any influence on the final price or total supply of a product - this is like saying that Boeing and Airbus have no influence on the ultimate price of airliners), no economies of scale (the more you make of things like steel, autos, and semiconductors the more the cost and prices decline), no international movement of labor and thus no immigration. I could go on, but you get the idea. The assumptions are not in the real world of much current international trade.

Beyond that, the current theory and practice of international trade totally ignores major aspects of the world in which it takes place. For example, global warming is a huge and growing concern of all countries and peoples. It is caused by the emissions of greenhouse gases. China is the biggest emitter of such gases. When China makes steel, it first imports coal from Australia to fire the furnaces. Coal is one of the worst fuels in terms of emitting greenhouse gases. The coal has to be shipped from Australia to China. Shipping accounts for about 14 percent of total greenhouse gas emissions. Once the steel is made in China, it is then often shipped to the U.S. or Europe or somewhere else for actual use. This results in further greenhouse gas emissions. If the total cost of these emissions were included in the cost and price of steel, much of it would not be made in and shipped from China. But those costs are never included in the final price. The situation is similar with semiconductors. They may be made in South Korea, shipped to by gas emitting airplanes to China, installed in a laptop computer that is then flown to market in the Netherlands, for example. None of that shipping cost will include the cost of greenhouse gases.

Finally, there is the factor of risk. Long, complex supply chains are risky by dint of being long and complex. The potential cost of that risk should be incorporated somewhere in the total cost and price of the product, but it is not now included. The result is that so called “free trade” can, in fact, become unexpectedly discontinued and costly.

As the world recovers from Covid and tries to avoid becoming more of a greenhouse, it is time to get real, and to discard the false assumptions and conclusions of free trade doctrine in favor of adding up all of the actual costs and producing and pricing accordingly.