Tear Down These Walls

Making the case for free trade


Free Trade Today, by Jagdish Bhagwati, Prince-ton, N.J.: Princeton University Press, 128 pages, $24.95

Free Trade Under Fire, by Douglas A. Irwin, Princeton, N.J.: Princeton University Press, 257 pages, $27.95

Doha, Qatar, has gained more than a little renown as the headquarters of the U.S. Central Command during the invasion of Iraq. But how many people know that Doha is also the place the current round of global trade talks was launched back in 2001? The war has turned out to be much quicker and more successful than the latest efforts to reduce world trade barriers. After two years, the negotiators haven't produced even the framework of an agreement. And they still seem to be arguing over what exactly they'll negotiate about.

Blame it on an understandable fixation on the fight against terrorism. Blame it on a slow economy and the difficulty in convincing people who are already scared of losing their jobs that increased competition from abroad is a good idea. Blame it on a large and vocal anti-globalization movement. Blame it on any number of factors. But judging from its lack of action and words on behalf of free trade, it is clear that slashing trade barriers is not at the top of the Bush administration's agenda. Or that of any other industrialized country, it seems.

Fortunately, two of free trade's most able defenders have written new books arguing for renewed efforts at opening global markets. Columbia University economist Jagdish Bhagwati's Free Trade Today is the slighter of the two, both physically and intellectually. That's largely because the book is just a collection of three lectures delivered at the Stockholm School of Economics in 1998. But it still makes some telling points.

Bhagwati notes that the case for free trade was first made by Adam Smith in The Wealth of Nations. "It is the maxim of every prudent master of a family, never to make at home what it will cost more to make than to buy," Smith wrote. "The tailor does not make his own shoes but buys them from the shoemaker….What is prudence in the conduct of every family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the product of our own industry, employed in a way in which we have some advantage."

David Ricardo later solidified the case for free trade with his theory of comparative advantage. Ricardo argued that even if an individual, or nation, was better than all others at producing everything, trade would still make sense. To use Ricardo's famous example, let's say that Portugal produces both wine and cloth more cheaply than England. But let's also stipulate that it makes cloth at half the cost of England and wine at one-third the cost of England. In that case, both countries would benefit if Portugal concentrated on making wine and sold it to England for cloth. They'd each have more cloth and more wine at a lower total cost. Today, most mainstream economists accept the basic case for comparative advantage, but some argue that there are important exceptions, instances where trade does not raise overall welfare.

Bhagwati's first lecture, "Confronting Conventional Threats to Free Trade: The Postwar Revolution in the Theory of Commercial Policy," ably tackles the neoclassical economic literature that "qualifies" the free trade case. He agrees with critics such as Princeton's Paul Krugman that if there are significant market distortions, free trade may make conditions worse. For instance, if wages are "sticky" downward and can't fall to market-clearing levels, competition from low-wage countries could theoretically cause an increase in unemployment so large that the loss in income outweighs the welfare benefits from trade. But Bhagwati argues that such examples of market failure are much rarer than critics contend. And even where they do occur, the best response is to correct the distortion and proceed with free trade, not to impose new barriers. Bhagwati further argues that even if there is a case where trade protection may be the best course, we may still be wise in following a general principle of free trade.

Drawing on the "public choice" literature of government failure, Bhagwati contends that in the real world protectionist measures almost never follow the "benign" models suggested by neoclassical critics of free trade. Instead, special interests capture the trade programs and use them for their own ends, ends that rarely serve the general welfare. "The invisible hand may be frail, but the visible hand is crippled," he writes.

Bhagwati's second lecture advocates delinking the social agendas of labor standards, human rights, and environmental protection from trade policy. "By trying to kill these two birds (i.e. social agendas and freer trade) with one stone (i.e. trade treaties and institutions), you are most likely to miss both," he writes. He sees sanctions against products made with child labor as misguided. Such sanctions often force children into even more dangerous and degrading jobs, such as prostitution. "To make a dent on the problem," he writes, "we need to do 'heavy lifting': for example, work with local [non-governmental organizations], ensure that children go to school when taken off work, and guarantee that the poor parents' incomes do not shrink below the survival line when the children's income disappears."

Bhagwati doesn't think the agendas advanced by human rights activists, environmentalists, and other critics of globalization are necessarily invalid. On the contrary, he calls for beefing up the International Labor Organization (ILO) to enforce labor standards. And he calls for more funding for international aid agencies such as the United Nations Environment Program, UNICEF, and UNESCO. He simply believes these issues should rarely be addressed in trade talks.

There's no doubt that the international agencies he stumps for have done some good work, but are big bureaucracies the best way to help the Third World? A more decentralized approach might do a better job. Microlending by commercial and noncommercial banks has helped many farmers and small business owners in the Third World raise their output and standards of living. Some of that has been aided by big international agencies, but much of it has been conducted without significant help from those organizations. It would have been nice if Bhagwati had at least considered this alternative.

Bhagwati's third lecture is perhaps the most interesting. In it he argues forcefully against bilateralism and regionalism in trade negotiations. These sorts of agreements, he says, create regulatory complexity and confusion in trade policy, especially in the administration of overlapping, contradictory, and mind-bogglingly complicated "rules of origin" requirements. Bhagwati calls this the "spaghetti-bowl effect": Firms and governments become tied up in knots of messy, discriminatory red tape, which makes little sense in a world of integrated cross-border production.

Take the North American Free Trade Agreement's complex rules of origin, which detail how much "North American" content automobiles must have to cross borders tariff free. These are designed to keep companies from simply importing goods from outside the free trade zone and selling them within it. Bhagwati also argues that such bilateral trade agreements entice the members of a free trade zone to discriminate against nonmembers.

Bhagwati thinks the best way to pursue free trade is through multi-lateral trade negotiations, such as happened under the General Agreement on Tariffs and Trade and is supposed to happen under the auspices of the World Trade Organization. But he also argues that unilateral reductions in trade barriers usually make eminent economic sense, pointing to the examples of countries that have benefited by unilaterally dropping their trade barriers, such as the United Kingdom in the 19th century and, more recently, Hong Kong, Singapore, and Chile. "We need to remember," he writes, "that if we refuse to reduce our trade barriers just because others do not reduce theirs, we lose from our trading partners' barriers and then lose again from our own."

At the same time, Bhagwati argues against what he calls "aggressive unilateralism," or the efforts of large economies to bully smaller ones into opening up their markets. He includes in this category actions brought under Section 301 of the 1974 Trade Law, which allows the United States to respond to the "unfair" trading practices of other nations by raising barriers against their products. Surprisingly, Bhagwati gives little attention to these attempts to force open markets, other than to say "no one likes a bully." Aggressive unilateralism does create an atmosphere of distrust among nations. Instead of looking for ways to benefit their citizens by reducing trade barriers, nations start to look for bargaining chips to play in international negotiations. And attempts to punish "unfair" trade rarely have been about opening up markets. Rather, they've been efforts at domestic protection. Domestic firms are almost always on the lookout for ways to exclude foreign goods and services. If they can do so under the banner of freeing trade, so much the better for them.

Bhagwati has discussed all of these issues at length in other venues, including The Dangerous Drift to Preferential Trade Agreements and The World Trading System at Risk. In a lecture format, of course, his time was limited, but it still would have been better if he had gone into a little more depth on this issue. While multilateralism and unilateralism may indeed be preferable to bilateralism in trade policy, regional agreements may not be as destructive as Bhagwati argues. Indeed, they may be the only path to freer trade when multilateral talks have come to a standstill, as appears to be the case in the Doha negotiations.

While Bhagwati's book deals largely with economic theory, Dartmouth economist Douglas A. Irwin builds a much more practical and empirical case for free trade in Free Trade Under Fire. Trade, he notes, is a vital engine of economic growth, especially in the United States, where exports and imports together make up about 25 percent of gross domestic product. Indeed, the importance of trade is growing. Exports accounted for almost 40 percent of merchandise production in 1999, up from just 15 percent in 1970. Further, the distinction between imports and exports is getting increasingly blurred. At least 3 percent of U.S. imports, worth about $25 billion, are actually domestic products that have been exported and then returned to the United States after further work abroad. The domestic content of this trade is especially large with Mexico and Canada.

"For one particular car produced by an American manufacturer," Irwin writes, "30 percent of the car's value is due to assembly in Korea, 17.5 percent due to components from Japan, 7.5 percent due to design from Germany, 4 percent due to parts from Taiwan and Singapore, 2.5 percent due to advertising and marketing services from Britain, and 1.5 percent due to data processing in Ireland. In the end, 37 percent of the production value of this American car comes from the United States." All told, 70 percent of all imports are used directly as inputs in American production, not consumed directly by households. That's up from 61 percent in 1950.

Protectionism would raise the costs of the raw materials and capital goods used by American industry. Irwin says new trade barriers, far from helping U.S. firms and American workers, would on balance harm employment in other domestic industries by raising their production costs. American workers would get hammered again by the higher costs for the goods and services they buy.

Some critics would argue that the link between imports and exports is not a necessary one. They might point to countries such as Japan and Singapore, which have allegedly grown their economies by focusing on exports while restricting imports. Irwin's case would have been strengthened if he had addressed this argument and the so-called Asian model of development closely.

Irwin does show how international trade improves productivity and raises standards of living. By increasing competition, it forces out the least productive producers and forces all remaining producers to adopt best practices. This allows the most successful firms to expand both domestically and internationally. Consider the introduction of Japanese automobile production methods and technology into the United States in the 1980s. Japanese firms brought their manufacturing methods to America directly, and American firms adopted the methods in new plants. Such improvements can be huge. Irwin points to the spectacular increases in agricultural output that have been attributed to the import of new crops and farming methods in countries across the world.

Many studies have demonstrated the productivity benefits from increased competition. In one nation after another, slashing trade barriers has led to a tripling or even quadrupling of productivity growth rates. In Canada, the North American Free Trade Agreement resulted in a 17 percent increase in productivity in industries previously protected by high tariffs and a 5 percent average increase for all manufacturing. "These productivity effects were not achieved through scale effects or capital investment, but rather due to a mix of plant turnover and rising technical efficiency within plants," Irwin notes. "By raising productivity, the [trade agreement] also helped increase the annual earnings of production workers, particularly in the industries previously most protected."

Not all of the benefits of international trade can be so easily quantified, but they are real nonetheless. Irwin points to the fall of the Soviet empire and the opening of the Soviet bloc to foreign trade. Almost overnight new foods, such as bananas and oranges, flooded into local markets, and the quality of previously available foods, such as potatoes, beef, and cabbage, improved. Irwin also cites the expansion of McDonald's into Asia. Asian restaurants had previously been noted for their dirty bathrooms, but McDonald's insisted on clean bathrooms in its outlets at all times. Soon, customers began to demand clean restrooms in other restaurants, and the owners had to comply or lose business. "The effect of such changes on aggregate output and income was minuscule," Irwin writes, "but the welfare gains from the availability of new and improved goods was not insignificant."

In Mexico, Chile, Taiwan, South Korea, and several other countries, political liberalization has followed economic liberalization and the removal of trade barriers. "Trade and economic development facilitate the growth of the middle class," Irwin argues. "It is within the middle class, if anywhere, that a broad ethic of civic responsibility and political engagement will develop to provide the foundation for both functional democratic governance and market economics."

If trade benefits nations, trade barriers cost them greatly. In the United States, sugar quotas alone cost consumers $900 million annually. The high price of sugar has cost the United States around 9,000 jobs in food manufacturing and refining, as many heavy users of sugar have closed down or moved their facilities to other nations.

Meanwhile, restraints on steel cost about $4 billion and restrictions on maritime shipping cost another $1.3 billion. Irwin cites one 1996 estimate that, all told, U.S. trade barriers cost Americans $32 billion annually.

Irwin is more critical than Bhagwati of the "social agendas" of free trade's critics. Bhagwati, for the most part, merely questions whether those agendas should be linked to trade policy. But Irwin shows that efforts to "strengthen" labor or environmental protections are often simply trade barriers in more pleasing garb. Bhagwati calls for strengthening the ILO and international aid agencies. Irwin isn't necessarily opposed to that, but he says those efforts will have only marginal effects on the living standards of workers. "Economic development is the only known way to increase wages," he writes. "The alternatives—massive foreign aid, stronger demands for social justice—are unrealistic or ineffective."

Indeed, if Irwin is right, strengthening global regulatory bodies may play right into the hands of those who would shut down international trade. "The more radical [anti-trade] groups have gained respectability by positioning themselves with mainstream organizations, such as moderate NGOs, UN agencies, labor unions and some political leaders and other public figures," he notes. This development raises the possibility that these NGOs and UN agencies have been captured or might be captured by special interest groups and ideologues committed more to curtailing trade than to improving the human condition.

That possibility points to a central weakness in both books. Bhagwati and Irwin assume their readers value growing economies and rising standards of living. For those who see commercialism and affluence as sins, the fact that free trade increases material welfare makes it all the more suspect. No economic argument will reach such critics. But these two books make a powerful case for free trade—a case that apparently must be made again and again.