Making The Case For Free Trade

A prominent banking economist takes on one of the great debates of the early 21st century - free trade, globalization and the intermingling of the world's economies.

The most contentious issue the cattle industry has faced over the past decade — international trade — keeps grabbing headlines. Whether it's clad in issues like disease prevention, food labeling or national security, trade policy continues to be a tug-of-war between free trade forces and protectionist ideology.

Despite some protectionist lapses, free trade has been a theme of both Democrat and Republican administrations since Harry Truman. It's the Americans who have led the charge in stripping away international trade barriers.

Americans have entered into economic alliances with Canada and Mexico under the North American Free Trade Agreement (NAFTA). Today, policymakers are hoping to forge a free trade zone stretching from the Bering Strait to Tierra del Fuego at the southern end of South America.

Michael Cox, senior vice president and chief economist of the Federal Reserve Bank of Dallas, hits protectionist doctrine head-on.

“Trade leads to prosperity,” he says. “Protectionism leads to stagnation and decline.”

It's a lesson learned decades ago from the Great Depression and more recently from the economic development gap between open West Germany and closed East Germany, says Cox.

Our Penchant For Imports

Most Americans are well aware of our penchant for importing, but they may not realize the U.S. ranks as the world's greatest exporter, selling $1.3 trillion/year to the rest of the world.

Globalization's critics attack open markets as an insidious force that destroys local industries, breeds poverty and dilutes cultures, says Cox. Their favorite targets are often American multinationals, such as Cargill and McDonald's. As we snap up food, cars and electronics from overseas, we still hear trade makes us poorer.

“It's just not so,” says Cox. “By enhancing productivity, it keeps U.S. companies vibrant, leading to fatter paychecks and added benefits.” Workers protected by trade barriers might keep their jobs a while longer, he adds, but the costs in inefficiency and higher prices make it economic folly.

“Whenever we erect barriers to trade, we negate the gains from free exchange and competition,” Cox says. “Trade protection degenerates into a negative-sum game where special interests jostle for advantage at the expense of the common good.”

The often-heard characterization, Cox says, is that exports are good because they support U.S. industry, but imports are bad because they steal business from domestic producers.

“Actually, imports are the real fruits of trade because the end goal of economic activity is consumption. Exports represent resources we don't consume at home. They are how we pay for what we buy abroad, and we're better off when we pay as little as possible,” Cox says.

Cheap imports can hurt higher-cost U.S. suppliers, but consumers certainly will gain, Cox continues.

“Why penalize them with tit-for-tat retaliation that only raises prices in the U.S.? As a society, we often have to choose between protecting domestic industries and opening markets. In a weakened economy, steelmakers, farmers and other producers are lining up to declare war on imports, creating a potential hit on Americans' wallets,” he says.

The Secret To Wealth

If we were to ask the secret to wealth, what would it be? Work hard? Get an education? Probably not, Cox says. Diligence and intelligence are strategies for improving one's lot in life, but plenty of smart, hard-working people remain poor.

No, explains Cox, the advice would consist of just a few words: “Do what you do best. Trade for the rest.”

Cox says that “By exchanging the fruits of their labor in the marketplace, each producer can enjoy more food, clothing and shelter than they could if each tried to meet his needs in isolation.”

Specialization and trade arise out of the profit motive. Except when transaction costs are too high or governments impose barriers, buyers and sellers will find each other. Self-sufficiency may sound noble in the abstract, but it condemns people to meager living standards, he adds.

“The American pioneers, living on remote homesteads and ranches had no choice but to produce just about everything on their own,” Cox says. “They embodied the virtue of self-reliance. Yet, they worked from sunup to sundown, seven days a week to eke out a subsistence living.”

Foreign goods also help keep a lid on prices in two ways, Cox points out, by being cheaper and encouraging U.S. competitors to lower their prices.

Over the past five years, U.S. prices have actually fallen for a wide range of traded goods, such as computers, clothing and toys. At the same time, inflation hit hardest at goods and services that face little or no foreign competition, such as college tuition and medical services, he says.

A Pocketbook Issue

“Trade is a pocketbook issue,” explains Cox. “Consumers' well-being, not corporate profit, is the true measure of an economy's success.”

The poorest consumers live in countries ranked as the most closed to the outside world, including Cuba, Zimbabwe, Laos, Libya, North Korea and Belarus, he says.

“Although trade protection makes no economic sense, just about every nation on Earth indulges in it to some degree,” admits Cox. “Producers want scarcity — high prices and fat profits. Consumers want abundance — many goods and services at low prices.”

Although consumers outnumber producers, those who seek protection often gain an upper hand. That's because producers are willing to invest more resources in reducing competition than consumers are in fighting for open markets. Consumers buy in thousands of markets. No individual possesses the time, energy and financial incentive to fight for lower prices in each of them.

Producers on the other hand, continues Cox, sell in one market. It gives them a strong incentive to focus on their own industry or jobs. Producers, unlike consumers, are usually few in number. Even if curtailing foreign competition adds only a few pennies per sale, each producer stands to reap a nice profit.

“So producers are willing to organize and spend big money in the fight for government favor,” he explains. “Protectionism persists because it's never pitched as a conspiracy to raise consumer prices. Instead, it's presented as a worthy idea. Who could object to saving American jobs or ensuring survival of industries vital to the national interest?”

Protectionism And Politics

Cox says protectionism persists because it's so often presented as a worthy idea. But, trade barriers don't deliver on their promise to save beleaguered industries, he says.

“Even when shielded from foreign competition, most protected sectors have continued to shrink,” he points out.

Protectionism fails domestic industries because it delays and weakens their response to market forces. When industries pursue political favors instead of efficiency or innovation, they only delay the inevitable.

Whether aimed at foreigners or fellow Americans, trade restraints aren't just a matter of lost dollars and cents.

“Protectionist schemes violate basic economic freedoms,” Cox says. “They involve third parties using the power of government to thwart the right of others seeking an exchange that will make them better off. Each time it happens, Americans are less free — and poorer.”

This article excerpted from the 2002 annual report of the Federal Reserve Bank of Dallas “The Fruits of Free Trade” by W. Michael Cox and Richard Alm. The essay is based on research conducted by Cox, senior vice president and chief economist, Federal Reserve Bank of Dallas.