It is fascinating how the much promoted concept of “free trade” has developed considering that the major industrial powers of the 19th, 20th, and 21st centuries have been built by using protective tariffs. Great Britain, United States, Japan and now China have all used tariffs to protect their fledgling industries from international competition by using tariffs. China has increased the tactic of administrative burdens, better known as “red tape” to slow the import process. In fact with the low tariffs by the U.S., China is basically in a trade war with us. It is not a major news story because we are not fighting! Congress just complains about the currency manipulation, which is only a symptom of large trade imbalances.
In research over the decades, I have been looking for a short and uncomplicated version explaining trade. I have found one by Paul Craig Roberts in “The Failure of Laissez Faire Capitalism”. I will be paraphrasing in this article, so I urge all of you to get the actual book. Except for monetary reform, he explains our current economic condition in less than 175 pages and he is from the Reagan administration. Another book to read is “Bad Samaritans-The Myth of Free Trade and the Secret History of Capitalism” by Professor Ha-Joon Chang from Cambridge.
A majority of economists have learned that to question free trade is to be labeled a protectionist. This label could be harmful to their careers. Most have not researched the theory, or its results. The big question is off shoring jobs part of trade whether free or not.
The theory of free trade was first developed by David Ricardo, a bond trader, over 200 years ago. Unfortunately, he was incorrect then and even more so now in the modern world where his two necessary conditions of “comparative advantage” are no longer present. In Ricardo’s time, unique national characteristics, climate, and geography were important determinants of relative costs. Today, however, most combination of inputs that produce outputs are knowledge based. The relative price ratios are the same in every country. Therefore, as opportunity costs do not differ across national boundaries, there is no basis for comparative advantage.
Ricardo’s other necessary condition for comparative advantage is that a country’s capital seeks its comparative advantage in its home country and does not seek more productive use abroad. Capital has become more mobile than traded goods. Indeed, capital can move with the speed of light, but traded goods have to move by ship or airplane. Approximately half of U.S. imports from China are the off shored production of U.S. firms for the U.S. market.
In the Ricardian free trade model, trade results from countries specializing in different activities where they have a comparative advantage and trading these products for the products of other countries doing likewise. Therefore trade is not competitive! Countries competing against one another in the same array of products and services are not covered by Ricardian trade theory.
Off shoring doesn’t fit the Ricardian or the competitive idea of free trade. In fact, offshoring is not trade. Offshoring is the practice of a firm relocating it its production of goods and services for its home market to a foreign country. The main reason is to lower labor costs and the secondary reason is to lower environmental costs. The third reason is to avoid some form of regulation or taxation. Now it is time to look at what economically happens, using China and the U.S. as examples.
As a function of offshoring, employment and wages decline in the U.S. This starts an increase in unemployment benefits (deficit spending) and a search for dollars by the unemployed (or reduced pay) in order to live or keep the same standard of living. This means, people start borrowing to live or for current spending. These loans are basically credit card and mortgages. Eventually people cannot support the debt service and the loans stop and/or default. We have the “Great Recession”. Then we have to be bailed out by excessive deficit spending and money creation given to the banks by the Federal Reserve.
Wages and employment increase in China. The major issue is the degree of difference! The basic hourly wage in China was $.71 in 2007 compared to over $20 in the U.S. (It is currently $2.25, still not enough to be a quality customer.) This was a small step up for the rural poor in China. But, they could not buy the products they were making! So, when the U.S. consumer stopped borrowing to buy, there were not enough well paid consumers in China to pick up the slack. So, China had to go into excessive deficit spending to support their economy.
The reason is microeconomic thinking instead of macroeconomic thinking! This translates to mean that labor/employees are also customers, clients and consumers. Microeconomic thinking is to lower costs to make more profits. Macroeconomic philosophy wants a large quantity of quality consumers creating a healthy economy. These goals are basically opposed to each other. Therefore, tariffs are needed more for the protection of our consumers. In fact, if we have closer wage parity (it does not have to be equal), limited environmental differences or excessive government financial support we could have nominal tariffs between nations. This means that we should have low tariffs between Japan and Europe and higher tariffs between low/slave wage countries and countries whose environmental costs are significantly lower.
Offshoring’s proponents claim that the lost incomes from job losses are offset by benefits to consumers from lower prices. Allegedly, the harm done to those who lose their jobs is more than offset by the benefit consumers in general get from the alleged lower prices. Yet, proponents are unable to cite studies that support this claim. The claim is based on the unexamined assumption that offshoring is free trade and, thereby, mutually beneficial.
Proponents of jobs offshoring also claim that the Americans who are left unemployed soon find equal or better jobs. This claim is based on the assumption that the demand for labor ensures full employment, and that people whose jobs have been moved abroad can be retrained for new jobs that are equal to or better than the jobs that were lost. This claim is false! Offshoring affects all tradable goods and services. The nonfarm payroll data collected by the US Bureau of Labor Statistics makes clear that in the 21st Century the US economy has been able to create net new jobs only in nontradable domestic services. Such employment is lowly paid compared to high value-added manufacturing and professional services. (Tradable goods and services are those that can be exported or that are substitutes for imports. Nontradable goods and services are those that only have domestic markets and no import competition.)
Some offshoring apologists go so far as to imply, and others even claim, that offshore outsourcing is offset by “insourcing.” For example, they point out that the Japanese have built car plants in the US. This is a false analogy. These car plants are an example of direct foreign investment. The Japanese produce in the US in order to sell in the US. The plants are a response to Reagan era import quotas on Japanese cars and to high transport costs. They are not producing cars in the US for the purpose of sending them back to Japan to be marketed. They are not using cheaper American labor to produce for the Japanese home market. At least not yet! They are using cheap Chinese labor.
Many feel that labor should be subject to demand and supply. This is again microeconomic thinking not macroeconomic thinking because these labors are the customers, clients, consumers and citizens of a country and now the globe. There are hundreds of millions of human labors that we do not need to produce all the needed goods and services; therefore, they are not quality consumers! Basic wage and fringe benefits should not be subject to supply and demand because if the demand for labor (and pay) is reduced so are customers. This becomes self-feeding continually reducing the demand until the government steps in. This is a subject for other articles please see, www.cpe.us.com the articles in the blog titled “Baxter is Here” and “Inequality and Solutions”.
The growing number of displaced and discouraged unemployed Americans is an external cost on taxpayers who provide unemployment insurance, private relief and welfare benefits, and on the viability of the American political and economic system. This cost far exceeds the excessive benefits to a few corporate executives and extra profits to shareholders. In fact domestic gross revenues (sales) are down!
We should be bringing the global economy up to our standard of living, like we did with Europe and Japan. Instead, these policies are bringing us down to their level!