Growing Discontent with Globalization, The Case for Open Markets

Comparative advantage is the main force driving international trade: countries open to trade would export what they are comparatively “good” at producing, and import what they are comparatively “bad” at producing. “Good” and “bad” refer to production costs, which, in competitive markets, define prices to consumers. Economists argue that international trade makes countries, in the aggregate, better off; through imports, consumers living in countries open to trade have access to goods and services at lower prices than they would have in the absence of trade. The increase in the purchasing power of consumers—and thus their welfare—achieved through international trade is what economists refer to as gains from trade.

There is no denying the fact that if international trade makes some people better off; it also makes some worse off. Thanks to international trade, consumers enjoy lower prices due to increasing competition from abroad. But, the welfare improvement of consumers offsets the losses of workers who are hurt if their wages are reduced or they lose their jobs.

This tradeoff prompts a number of questions: How is welfare measured? How is it aggregated? How allowing some people to save money when buying imported things offsets the fact that workers in local factories might lose their jobs? The difficulties in responding to such questions with simple answers is part of the reason why international trade is being questioned by large sectors of populations and exploited as a scapegoat for economic woes by populist politicians.

Discontent with globalization is nothing new. But today, this dissatisfaction has become ubiquitous as reflected in the triumph of Brexit or Donald Trump’s election as US president. Until now, globalization was not such a controversial issue rather the world as a whole embraced international trade, and most countries progressively eliminated trade barriers and created global institutions to further free trade. A large-scale multilateral effort to reduce trade barriers between countries resulted in the 1947 General Agreement on Tariffs and Trade, known as GATT, signed by twenty-three nations. The World Trade Organization (WTO), founded in 1995 as the successor to GATT, today has 164 member states. According to the WTO, more than four hundred regional trade agreements covering trade in goods or services have been created or reformed since the establishment of the WTO.

In 2017, it certainly feels like the free trade party is over. With the European Union about to formally lose its second-largest economy, and the Trump administration pushing a protectionist agenda – withdrawing from TPP, renegotiating NAFTA, etc. – international trade might slow down in the near future.

However, it is highly unlikely that protectionism will revive the manufacturing jobs lost over the last decades in advanced economies such as the United States. To understand why, let’s look first at the rationale behind the claim that links trade to job losses.

President Trump’s rhetoric suggests that taking advantage of wage differentials between the US and other countries like Mexico or China, a number of American firms have moved their factories abroad. They serve US consumers by exporting from those locations to the US at no additional costs beyond transportation taking advantage of low or no import tariffs due to trade agreements.

Since NAFTA came into force in 1994, America’s imports from Mexico have increased much faster than its exports to the latter so much so that US-Mexico trade deficit stands today at about $60 billion. And since then, the US has lost about five million jobs in the manufacturing sector. A similar case is made about China, with which the US has its largest trade deficit, about $350 billion a year. Although these figures bolster President Trump’s argument, yet the story is not so simple. Trump relies on the trade deficit to call trade deals “unfair.” But there are a number of angles, and many more data points, that should be taken into account before making those claims and, more generally, before assessing the benefits from trade.

The Import-Export Conundrum

Often, the trade deficit with a particular set of countries is offset by a trade surplus with other countries. Overall, the US has a trade deficit of about $450 billion a year. Bilateral trade surpluses with Hong Kong, Australia, Chile and Brazil, for example, offset part of the deficit with countries such as China, Mexico, Germany and Japan. Thus, in this sense, the bilateral trade deficits are meaningless as they do not reflect the big picture.

Trump’s obsession with the trade deficit might push his administration to take steps that might change bilateral deficits but they won’t impact the overall deficit. For instance, imposing import tariffs on Chinese goods will not really affect the overall trade deficit. Yes, goods and services from China will become more expensive to American consumers and they might decide not to buy them. But will consumers find substitutes in America? Likely not!

Following the imposition of import tariffs, consumers will have to rely on other countries that can competitively produce those goods and services. Even if imposing tariffs on China or Mexico could potentially reduce the US trade deficit with them, it will most certainly increase it with other countries that are their competitors. Thus, the overall trade deficit will, at best, remain the same.

Now let’s turn to the aggregate trade deficit: is it bad for the US to run a large trade deficit? It depends. America’s trade deficit accounts for about 2.5 percent of its GDP. Naturally, deficits create debt. But debt is not good only when it cannot be paid or when others suspect it cannot be paid. That is not the case with the United States. In terms of public debt, judging by the markets, America is the safest country of all.

The overall trade balance won’t be affected by renegotiations, taxes or tariffs. This is because the trade deficit reflects a more structural characteristic of the US economy: the low levels of domestic savings. Basic macroeconomic accounting shows that the trade deficit equals the difference between domestic savings and total investment in the economy. The low level of savings is partly encouraged by the monetary policy put in place by the Federal Reserve following the Great Recession of 2008; low interest rates encourage consumption and discourage savings. Thus, monetary policy could play a role in reducing the trade deficit by encouraging Americans to save more. But this is particularly delicate in a still-recovering economy. Increasing the interest rate too much and too fast might roll back the post-recession progress that the US economy has made.

Productivity and Progress

All advanced economies lose jobs in their manufacturing sector, regardless of whether they were running a trade surplus or a deficit. The US is not an exception to it.

While the US lost five million jobs in manufacturing since NAFTA was signed, it increased its manufacturing output by $800 billion. This is the additional data point that President Trump has ignored all along. It hints of a very important point: the vast majority of American jobs that vanished in manufacturing were not lost to Mexico or China or any other country; they were lost to higher productivity. On average, American workers produce 50 percent more today than they did in the early 1990s.

In fact, as per various researches and studies, the net job losses that can be attributed to trade with Mexico and China are estimated to be 100,000 and 300,000, respectively – less than 0.5 percent of the overall labor force.

These relative small numbers in net job losses reflect an important reality; while some jobs were being destroyed due to trade; many more jobs were being created thanks to trade. One way to look at this is by examining the nature of imports from Mexico to the United States. According to data from the US Census Bureau, more than half of those imports are considered intermediate goods—capital goods, industrial supplies and materials destined for production in the United States. On top of that, another close to 20 percent are intermediate goods for the US automotive industry. The largest beneficiaries of Mexican goods are firms, not consumers. These firms have access to raw materials and intermediate goods that make them more competitive and able to sell their final goods not only within the US but also to the rest of the world. In the absence of free trade with Mexico, many American firms wouldn’t be able to compete in global markets.

However, by no means should we minimize the pain and suffering of those who lost their jobs. It is a fact that many workers became unemployed because the firms and industries for which they worked, sometimes for decades, were not competitive enough to survive the increasing competition from foreign imports. This is a very unfortunate outcome of international trade.

Yet, the damage can be contained without giving up on international trade. If the Trump administration truly wants to stand out from its predecessors, its response to the valid discontent among those adversely affected by international trade would be to provide safety nets to transition to another career or, if necessary, to retirement. These safety nets have been completely missing from the equation. President Trump has the opportunity to become a champion of the middle class by putting away his anti-trade rhetoric and instead focusing on social programmes that can offset the damage created by international trade among some communities.

Republicans and even some Democrats will oppose the safety net option and ask, “Why should the government support workers who lost their jobs?” From strict economics viewpoint, they do have a point. Competition leads to job losses as it is the nature of free markets; therefore, there is no justification for government intervention. But this time is arguably different: providing safety nets to workers who lost their jobs to international trade is the compromise that should emerge so that democracy and globalization can coexist together, and hopefully reduce the likelihood of future “shocks” to the system that can endanger both of them.

Harsh Reality

International trade is one of the catalysts in the process through which less productive firms die and other more productive firms are born. As part of these dynamics, workers and other resources flow from the least to the most productive companies or industries. The fast growth of South Korea and other Asian economies during the last half of the twentieth century is mostly the result of this process, as documented by many studies.

The world has been experiencing a productivity slowdown since the mid-2000s. While the fundamentals behind this slowdown remain unexplained, most economists agree that it represents the biggest challenge faced by the United States and other advanced economies. Nothing besides productivity growth can sustain long-run economic growth. It is more competition and more trade, not less, that is required to jumpstart productivity growth. Conversely, any policy aiming to reverse the advances the world has seen in free trade could have longstanding negative consequences to global economic growth. No worker, consumer or politician will be immune to that reality.