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Free Markets, Libertarians, Trade Deficits, Economic Decline: Joseph Cotto Interviews Ian Fletcher

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Journalist Joseph Cotto interviewed me recently. Our conversation is below.

Q: Today, many people tend to confuse the concepts of free markets, free trade, and fair trade with one another. How would you describe each?

A: "Free markets," like most political terms, can be debated, but it basically just means capitalism without government regulation or private monopolies. "Free trade" means there are no taxes on imported goods greater than those levied on domestic goods, and no quotas or other restrictions to block imports. Obviously these are both purist concepts that don't literally apply in the real world, and what people mean when they use these terms is minimal regulation and minimal barriers to trade.

"Fair trade" is an entirely different matter, as there are many different concepts of fairness. I would say fair trade means, above all, genuine reciprocity: when the U.S. opens its markets to foreign nations, they extend us the same privilege, for real and not just on paper--which is not what tends to happen now. Fair trade would thus mean an end to the mercantilism of foreign nations like China, where they game the system to run up huge trade surpluses against us. People further left than me, like Ralph Nader, would probably say fair trade has to involve not allowing trade to increase income inequality in this country, which is a legitimate concern because "free" trade has been doing that in recent decades.

Q: Prominent economists and politicians often say that free trade will only benefit America in the long run. You beg to differ. Why is this?

A: For a start, economic history simply does not support the proposition that free trade is best. The U.S. was an avowedly protectionist country for most of its history, during which time it turned from a Third World backwater to the greatest industrial power in history. The same pattern, rising to economic greatness under protectionism, has also been true for nations like Britain, Germany, Japan, Korea, and now China. So the hard data is against the free traders. And when you look into the economics underlying this fact, you discover pretty quickly that free trade can only really be best if the absolutely pure 100% free-market model of a successful economy is true. And that's not something that anybody--Left, Right, or center--has practiced in domestic economics for decades now, whatever rhetoric they may employ. There's a good reason for that: market purism doesn't work. We don't have a pure 19th-century laissez faire robber baron economy domestically, so why should we have one internationally? We've learned the hard way, most recently in the financial crisis, that too little regulation can do as much damage as too much.

We need to extend that lesson to international trade. The economic theories, like David Ricardo's famous Theory of Comparative Advantage, that supposedly prove free trade is best, are riddled with loopholes, which are actually quite well-documented. They assume you don't have chronic trade deficits. They assume prices perfectly reflect value, that you have no so-called externalities. They assume no unemployment. They assume no short-term thinking, no debt binges, no bubbles. They assume no international capital mobility. They assume free trade doesn't help your foreign rivals take your industries away from you. They assume that short-term economic efficiency is the origin of long-term economic growth--which it isn't.

Q: Libertarian economic theorists tend to believe that trade deficits are of minimal importance. What is your opinion on the subject? Do these deficits really have a great impact on America's economy?

A: Libertarianism is not a school of economics. It is a philosophical position that says maximizing freedom is always the right thing to do, in economics and every other policy arena. Libertarians are entitled to believe any philosophy they like, but political ideology and economics are simply not the same thing. Trade deficits are important because there is no free lunch in this world. When we import more than we export, we are consuming more than we are producing, and the difference has to come from somewhere. It comes from selling off our accumulated national wealth and from sinking deeper into debt. Americans are worse off because we own less and owe more. Libertarians are indifferent to this because they say, "Hey, we freely chose to live irresponsibly. So it must be OK." But freely choosing to stick your head in the oven doesn't mean it won't kill you.

Q: Since it went into effect during late 1995, the North American Free Trade Agreement has formed a trilateral commerce bloc between Canada, the United States, and Mexico. From your research, has this proven to be of benefit to our country?

A: No. It has worsened our trade deficit and undermined wages in the United States. Ross Perot was an odd individual, but he was right about NAFTA. That's fairly obvious now. The Department of Labor says NAFTA cost us over half a million jobs. This all should have been obvious beforehand. Mexico was far too poor a country to become this vast market for American consumer goods we were promised. I think the people who framed NAFTA actually knew this. Paul Krugman has written about how the economic projections of the Clinton administration were blatantly faked, about how it was all driven by a political agenda with the economics tacked on as a rationalization. And Mexico has been losing its manufacturing to China, so it hasn't been a great success for them, either.

Q: Recently, the federal government approved further free trade agreements with South Korea and several Latin American countries. What sort of effect should these be expected to have on the U.S. economy?

A: Our trade deficit with South Korea is already up sharply. The reality is that these trade agreements are not a solution to America's trade mess, because our big trading partners are practicing various kinds of mercantilism and these agreements are predicated on the assumption that both sides are like the U.S. in not having any conscious trade strategy at all. Now they're adding Canada and Mexico to the proposed Trans-Pacific Partnership, and U.S. Trade Representative Ron Kirk has said he'd "love nothing more" than to have China join. A free trade agreement with China? That's a truly frightening thought.

The other problem with these agreements is that they're so secretive, so anti-democratic, so lacking in public accountability. Why should we sign away our right to make our own laws, on everything from labor standards to environmental protection to financial regulations? Why should we sign treaties where even U.S. senators have a hard time finding out what's being put in them? Why should we let foreign judges supervise our economy or give foreign investors rights Americans don't have?

Q: China is notorious for its currency manipulation schemes. Beyond this, however, it not only owns a tremendous amount of America's national debt, but accounts for much of our trade deficit as well. How do you suppose that the U.S. could level the playing field in the near future?

A: We can stop China's manipulation of our currency any time we have the political will to do so. All we have to do is stop selling them our debt and assets. The underlying economics is not complicated, because the only way you can drive a currency up or down is by supply and demand, same as with anything else that has a price. If we end the artificial Chinese demand for dollars caused by their government's purchases of our debt and assets, we end the problem. There have been cases of currency manipulation that were stopped before.

Unfortunately, the "American" multinational corporations that are pulling the strings in the Obama White House don't want this problem solved. They make so much money producing for export to the U.S. from China that they don't want any change to the status quo. Beijing also plays them like a fiddle and forces them to lobby on China's behalf in exchange for access to China's cheap labor. The White House has apparently forbidden the U.S. Trade Representative from even talking to China: only the Treasury Department and the White House itself are allowed to do that now. This is a national-security problem, too.

Q: One of the reasons that the American economy consistently fails to emerge from the Great Recession is that it produces a decreasing number of material goods. What would you say can be done to reinvigorate our manufacturing sector? Honestly, is this even possible now?

A: The single biggest thing we can do to restore the strength of American manufacturing is cut the trade deficit. And yes, we can restore American manufacturing. Those industries that have survived in this country have shown enormous productivity growth in recent years: it's a myth that Americans can't do these things well anymore. And other nations with factory wages even higher than the U.S., like Germany, have booming manufacturing exports--you don't have to be a cheap-labor economy to win at this game. You do have to have a coherent national economic strategy, which is something the U.S. used to have. Strategy has got to stop being a dirty word, like it's Soviet-style central planning.

Q: Illegal immigration poses an astounding threat to America's economy. Just a short time ago, President Obama signed a mini-DREAM Act of sorts which will allow an estimated 800,000 illegals to avoid deportation. What do you think that the ramifications of this will be?

A: Immigration isn't an issue I work on.

Q: Many political forecasters are saying that the future of the American center-right belongs to libertarians; specifically those of the Ron Paul variety. Do you share this view? Regardless, from your perspective, would the U.S. economy would fare well under strong libertarian influence?

A: No, I do not. Libertarians are a noisy minority in the Republican party but not even close to numerous enough to take it over. Love of liberty is very much in the American grain, but libertarianism is something else: a philosophical cult that is superficially attractive on first glance but ends up disappointing most people when they realize all its weird implications, from crank economics to sexual libertinism to this odd "we're not racists but people should be free to discriminate" position that Ron Paul has come under fire for. Libertarianism is like socialism: it attracts precocious teenagers but most people grow out of it as they get experience in real politics and see that you can't reduce it all to one thing, not even freedom.

If all you mean by a "strong libertarian influence" is giving free markets and private property their due, then we're there already and have been for a long time: this country is more free-market and private-property oriented than most other major economies. The results, the pluses and minuses, are all around us: we're good at things that depend mostly on a strong private sector, but lag other nations in the provision of public goods. If you mean having the U.S. adopt libertarian crank ideas like abolishing the Fed or returning to the gold standard, then we'd be in for a rough ride. The U.S. economy in the late 19th century, when we actually implemented such policies, was considerably poorer, nastier, and more volatile than what we have today. The hard data is out there if you want to look.

Q: Now that our discussion is at its end, many readers are probably wondering exactly how it was that you came to be one of America's foremost advocates for fair trade. Tell us a bit about your life and career.

A: Well, I studied at the notoriously free-market University of Chicago, but they were actually fairly honest about the limits of free-market thinking, much more honest than some of the ideologues out there. They taught that there were all these anomalies in markets, that you couldn't just believe in markets as a matter of faith, you had to have empirical evidence. So I was never an outright Kool-Aid drinker of free trade or any other form of free-market extremism. Then I ended up, years later, as an economist in private practice, serving hedge fund operators, private equity guys et cetera, researching quirky outside-the-box stuff that other economists didn't want to touch. And I eventually got tired--this was before the crash--of helping people with too much money make even more. About this time, I was also getting worried about the trade deficit, so I went looking for a book that would really put the idea of free trade on trial and let me decide if I supported it. And there wasn't one. So I decided to write it myself, and I found out that free trade really doesn't stand up to serious scrutiny.