As Trump takes office, more economists are questioning whether unfettered free trade works"

December 12, 2016


[ Tom Holland| November 28, 2016 |SCMP]

Among the few hard and fast policy prescriptions to emerge so far from Donald Trump’s transition team is the US president-elect’s pledge, delivered last Monday, to tear up Barack Obama’s Trans-Pacific Partnership trade deal on his first day in office.

Calling the TPP “a potential disaster for our country”, Trump promised to replace his predecessor’s multi-lateral agreement with a series of bilateral trade pacts he said “will bring jobs and industry back onto American shores”.

Most Western economists roundly condemned Trump’s move, declaring that his protectionist stance would harm American consumers and corporations, diminish US influence in Asia, and damage the US economy’s future growth prospects. Unimpeded international trade, they insisted, was a positive sum game, which enriches all participants, not just Asian exporters to the US.

Trump clearly disagrees with the conventional wisdom, regarding free trade instead as a zero sum, in which Asian countries benefit and the US loses out. Yet although Trump’s is a minority view among economists, a growing number are beginning to question the conventional attitude, asking whether unrestricted trade really is as beneficial as the accepted theory dictates.

Belief in the advantages of free trade dates back to the early 19th century, when the English economist David Ricardo outlined his theory of “comparative advantage”. In a nutshell, this holds that open markets benefit everyone because each economy can then concentrate on activities in which it has a competitive edge, maximising overall efficiency.

However, a number of influential economists have lately begun to question whether international markets are really as open and as freely competitive as the consensus believes. In a truly open market, it is not just sellers of goods and services that compete with each other, but also buyers – and in particular buyers of labour. In an open market in which many employers compete for workers, each has a powerful incentive to increase the wages it pays in order to attract and retain the best staff. As a result, pay rises until the additional cost of hiring new workers equals the extra revenue a company can hope to generate by expanding its labour force.

But in a concentrated market, in which a relatively small number of employers occupy dominant positions, then each has an incentive to cut costs by paying lower wages. By doing so, they may force some workers out of the labour force, meaning overall economic activity falls. But fatter margins mean bigger profits for employers and their shareholders.

A growing number of observers believe that this is what has happened in the US economy in recent years. A paper published last month by Barack Obama’s Council of Economic Advisers noted that “industries have become more concentrated” and that as a result “employers may be increasingly able to exercise wage-setting power in US labour markets”, so holding down incomes.

In order to redress the balance and push up pay, the solution, argued the paper’s authors, is tighter labour market regulation and greater workers’ rights, and in particular the enforcement of a higher federal minimum wage. However, in many fields, that simply won’t work. In manufacturing especially, big companies can simply relocate their operations to lower-cost jurisdictions offshore, comfortable in the knowledge that under free-trade rules, they will still be able to sell their products into the US market.

The conclusion that a small but increasing number of US economists are reaching is that if policy-makers want to boost incomes for American workers, it will be necessary to impose restrictions on free trade in order to prevent big companies moving jobs to cheaper locations offshore. As Dani Rodrik, professor of international political economy at Harvard, wrote last month: “If domestic labour standards are eroded due to international competition with countries where workers have few rights, it is trade that should bear the brunt.”

In other words, free trade isn’t all it’s cracked up to be, and an element of trade protectionism is justified in order to support incomes for workers in the developed world.

This of course, is pretty much what Trump has argued to the horror of most mainstream economists in the West. Curiously, however, his line of reasoning is not remotely controversial in Asia, where governments have long recognised the importance of protecting domestic industries from the chill winds of international competition in order to raise incomes. In the early 1960s, Japan imposed punitive tariffs on imports to nurture favoured industries. Both Korea and Taiwan employed the same strategy in the 1970s. And in recent years China has deployed a range of non-tariff barriers to help chosen sectors to develop untroubled by outside competitors. As a strategy, protectionism worked handsomely for Asian economies. Whether it can work for Donald Trump’s America remains to be seen. But a growing body of opinion holds that the attempt may not be as misguided as most Western economists have long believed.

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