Support for free trade is declining for good reason. Free trade came with a promise of prosperity. However, after 20 years of experience, we have structural trade deficits and an economy that cannot create jobs.
What went wrong with free trade?
First of all, free trade is orthodoxy, not science. Free trade orthodoxy stands on the Theory of Comparative Advantage, a great philosophical accomplishment of the 18th and 19th centuries. Unfortunately, Comparative Advantage is highly idealized and fundamentally flawed. It ignores the real-world conditions of 21st century globalization.
- Comparative Advantage assumes full employment.
In the real-world 21st Century global economy, we have a huge surplus of cheap labor around the world.
- The highly idealized theory of Comparative Advantage assumes that all investment stays within each country's domestic economy.
With 21st century globalization, capital flows freely from high-wage countries to low-wage countries. New investment builds production platforms in low-wage countries, producing goods to be consumed in high-wage countries. Perversely, venture capitalists often insist that production be moved offshore as a condition for making new investments.
- Orthodox trade theory assumes balanced trade.
However, in the real world, low-wage countries can produce at prodigious levels, while their consumption is tiny by comparison. Under real-world conditions, low-wage countries can sustain trade surpluses for my remaining lifetime, and America will experience structural trade deficits.
- Conventional free trade models assume workers can change jobs and occupations without loss of earning power. Assistance with retraining will resolve any friction in the labor market.
In the real world, when a factory moves offshore, high-paying manufacturing jobs disappear, replaced with lower-paying service-sector jobs or long-term unemployment.
- Orthodox trade theory assumes that currency exchange rates adjust readily under market forces.
In the real world, China manipulates its currency, and lends us money to buy goods. Furthermore, the dollar enjoys special status as the world's reserve currency, building a negative bias into our trade balance.
- Finally, idealized free trade theory assumes a world frozen in equilibrium, where no new products or processes are ever introduced.
In the real world, we lose strategic position as our economy de-industrializes. By the same token, low-wage countries gain strategic advantage as they build up their industrial infrastructure and develop skilled workforces. American companies stopped making memory chips. We conceded production of LED's LCD's, flat screen TVs, and iPhones. Years from now, other countries will have competitive advantage for 3-D TVs or other advanced electronics.
In each case, the assumptions of free trade overstate gains and understate risks.
As Joe Biden might say, these are big deals. Comparative Advantage is discredited in terms of logic, experience, policy, and common sense. It survives in the land of punditry.
We can understand the tyranny of this dead idea by looking at those interests which are well served by prolonging our free trade policies. Free trade works very well for investors, financial institutions, and large multinational companies. At the same time, our free trade agreements push aside interests of workers, communities and the environment.
To see this in action, look at three global financial institutions, each designed to enforce the rules of free trade - WTO, World Bank and IMF. These institutions serve the interests of banks, large corporations, and investors. They do play a role in humanitarian projects, but their primary purpose is to enforce interests of business and investors.
When we industrialized, our strong civil society pushed us to a different approach. We created strong public institutions, such as the Environmental Protection Agency, OSHA, the FDA, the National Science Foundation, the National Institutes of Health, among others, all dedicated to public interest. Where are the global institutions that promote these important interests of civil society? When we regulate carbon, or protect natural resources, or defend human rights, we should expect global institutions to act with enforcement powers comparable to the powers we've already given to the WTO, IMF and World Bank.
Professor Jagdish Bhagwati wrote a defense of free trade, which he expressed in terms of 3 "I's" - ideas, interests and institutions.
I say those same 3 I's - ideas, interests, and institutions - make a stronger, more coherent argument against free trade, revealing a bankrupt theory with a predictable track record of failure.
We need a new trade policy. No country in the world is pure free trade or pure protectionism. Countries around the world have found middle ground including an industrial policy to guide their development.
If we intend to rebuild our middle class and re-industrialize our economy, we will need a national industrial policy that recognizes the interests of environment, labor rights, human rights and public health, in balance with investor and business interests.
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