Free Trade, Faux Trade: An Analysis of U.S. Economic Policy Tuesday, March 18, 2008

The following is a paper written by a former Columbia University student of economics, Allen Sukholitsky. It has been posted with his permission.

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It is not a far cry to state that much, though not all, of what the classical economists had written by the start of the 18th century, has been accepted to date. Free trade, has not been. The problem is not one of theory or concept. Individuals trade freely with each other inside the historically and arbitrarily defined borders of countries. Again, they are arbitrary and a product of history. But what gives these borders such monumental significance, is the fact that there is a history and culture to that which has existed within those borders; it is a history and culture that often separates the territory within from the territory without. The ability to free trade lawfully-acquired private goods domestically spurs competition, allocates resources, and leaves society better off as a whole. There is no reason why expanding the theory to the international realm should yield different results. In the wholly idealistic but theoretically feasible anarcho-capitalist model, the economy of the earth would simply resemble an enlarged domestic economy; goods would be produced in the cheapest locations and individuals would be compensated for their labor based on their marginal productivity. So, what is it about free trade that has professional economists adamantly opposing one another?

The answer is a combination of factors. First and foremost, but also a topic that this paper will not address, is that of the cultural and historical differences from within vs. those from without. Economic theory might work as it does, but there seems to be an instinctual human hesitation to apply it globally given peoples’ attitudes to their own land. International trade is controversial because it is thought to benefit a distant other’s well-being at the expense of one’s own. One topic this paper will address is the highly restrictive definition of free trade that has emerged since David Ricardo. And concomitantly, what it is that has been considered free trade policy, and how have the results of this policy been interpreted. How closely have the specifics of NAFTA and other trade policies in the U.S. been analyzed when evaluating how free is American trade? Since free trade is a priori beneficial, why has the American middle class been abandoned by businesses moving overseas after the passage of NAFTA? Does adherence to NAFTA mean adherence to free trade? What if such rancorous results relayed by individuals across the political and economic spectrum for over a decade are not those of just eliminating tariffs? These questions are critical for the purpose of advocating the benefits accrued from free trade.

This paper attempts to expand upon, not to challenge, the standard definition of free trade. This definition does indeed include the elimination of tariffs, but also adds cross-border flows such as foreign aid, country-specific domestic policies like taxes, regulation, and other similar elements which affect trade, to the definition. In addition, this paper takes this more elaborate definition and applies it to the policy dimension. Is the U.S. a proponent of free trade because it passed NAFTA? To clarify, the current definition of free trade focuses mostly on tariffs, and it is to this extent that this paper questions if NAFTA is only about free trade. Is there more to NAFTA than just tariff elimination? The expanded definition is meant to provide a more wholesome view of international trade in light of NAFTA and other American trade policies; the expanded definition is meant to demonstrate that the agreement and other trade policies have both trade promoting and trade restricting measures; the latter often go unanalyzed but relate to the negative observed results since NAFTA’s passage. Finally, this paper analyzes the implications of the results and how they measure up to empirical evidence.

As the market economy is driven by human action, inherently composed of a multitude of factors, analyzing the extent to which the market is being permitted to function in terms of specific economic concepts (welfare, regulation, etc.), proves difficult. Worse yet, ceteris paribus assumptions that work in the theoretical realm by permitting singling out certain policy, can be ineffective for assessing the aforementioned when policies are real and multifaceted. Finally, deciphering what characteristics of actual policy do and do not relate to certain broad economic concepts like trade, complicates matters even more so.

To bring these presently theoretically heavy ideas into clarity, they should now be applied to trade. The thought of trade conjures the related notion of exchange. Exchanges can take place on many levels including that among individuals, that among groups, and that among nations. In addition, there are elements that can induce exchange or reduce exchange. This holds for every level of trade that takes place. For instance, trade between two individuals is not only reduced by prohibiting them from trading. It is also reduced by quantifiably limiting their trade, or by requiring side payments for the trade to occur, or even by forcing either or both of the participants to produce that which they trade under artificially strenuous conditions. All of these affect trade in an unnatural manner. Each of these factors affects trade and each of these factors can, once again, be applied to every level of trade that takes place. To measure the amount of freedom that the two individuals possess, it would entail looking at most if not all of that which affects trade.

Modern economics textbooks more than adequately detail the reasons why trade among nations is overall beneficial to everyone when intervention in the trade is minimal or nonexistent. Krugman and Obstfeld write, “Probably the most important single insight in all of international economics is that there are gains from trade…” (Krugman 4) What modern economics textbooks do not detail adequately, are the plethora of possible impediments or artificial inducements to trade. Krugman and Obstfeld title their section on this subject, “Impediments to Trade: Distance, Barriers, and Borders” (Krugman 15). The fatal flaw in this highly restrictive analysis is to assume that the extent of trade among nations is a product of the barriers that exist literally in between the nations; this definition of impediments ignores the barriers/stimuli within nations that have just as much an effect on trade among nations, though possibly less visible to the eye than distance, barriers, or borders. For instance, if two countries did not have any tariffs or quotas but one of the countries offered foreign firms extraordinary discounts/premiums on the inputs for the firm’s outputs, thus enticing/discouraging foreign firms to enter the country, would this situation be deemed an example of free trade? It is this type of recognition that is indispensable to the question of how free is American trade in general and how free is it, given NAFTA. The focus is obviously not meant to be on the label “free trade,” but rather is meant to be on what affects trade, how NAFTA relates to those aspects and if the consequences of NAFTA are the consequences of free trade.

The scarcity of economic theory on real life domestic impediments to free trade is likely a result of any number of reasons. Regardless, this hole in the theory has not remained unnoticed. James R. Markusen has addressed the economics profession on the topic of foreign direct investment, accordingly.

Markusen’s sentiment was aimed at foreign direct investment in particular but at the end of the quote it is evident that he is getting at the idea that, in the most general terms, there are many factors that affect economic phenomena. This is just as applicable to trade, as it is to foreign direct investment. The economic literature needs to move away from the long established impediments of tariffs and quotas, and into areas like special relationships between governments and foreign producers within their countries, tax rules including exceptions for foreign producers, regulations including safety and environmental, loans at favorable exchange rates for certain producers, the dynamics of foreign aid, and essentially all the other myriad reflections of extra-market activity that indubitably affects trade.

Admittedly, economists have delved into the interplay of market and non-market activity, but it has not been for the purpose of determining the extent of free trade. It has primarily been used to evaluate, for instance, the cooperation/conflict between international firms and governments, with the goal of deducing the conditions under which these take place; in essence, it is to understand the dynamic of the relationship rather than to use it as a measurement of free trade (Frieden 1994; Henisz 2000; Jensen 2003; Moran 1978). But using this just-discussed elaborated upon though highly primitive expanded definition of trade, which encompasses the obvious barriers literally in between countries, the domestic regulatory environment, the relationships between governments and foreign producers, and all flows of funds across borders, is essential to the question of how free is free trade. Restricted trade is characterized both by what it restricts and by what it artificially induces. The picture of free trade is simply unclear when looking only at tariffs or quotas.

These new additions to the definition must now be clarified as to how they can affect trade and why it is important to consider them for an adequate survey of free trade. The domestic regulatory environment might at first thought be irrelevant to international trade. However, with the recent movement of capital and entire businesses overseas, the environment under which they will function indeed comes into play. Low regulation environments can induce businesses to move abroad while high regulation environments do the opposite. Included in a regulatory environment are such policies as tax laws, labor standards (working conditions, minimum wage laws, etc.), environmental protection laws, and likely many others. In addition to domestic regulation, governments can also maintain special relations with foreign producers in mutually beneficial relationships. The producer is given preferential treatment in the foreign country, and the government of the foreign country is able to attract firms it might not have been able to under normal market conditions. Finally, the flow of funds across borders is not trade in goods or capital but trade in actual money. This can include foreign aid, business subsidies, loans, etc. When these funds are provided from one country to another by the government, the position of the latter is benefited at the expense of the former. These examples that fall outside the category of tariffs/quotas/distances enlighten the characteristics of trade relationships among countries.

With the expanded definition of trade set in place, it might be helpful to construct some theoretical metaphors to view the specifics of NAFTA in a new light. The metaphors concern real world entities and situations though their probability of occurrence is quite low. The level of exaggeration is meant to prove a point, not to claim that these situations are likely to occur. Combining the new definition of free trade with the insights of the metaphors will reveal that NAFTA qualitatively promotes and restricts trade and it is this combination that is responsible for the observed results.

i. Minimum Wage Reduction Act

Imagine a piece of legislation called the Minimum Wage Reduction Act is proposed in the United States. While the minimum wage is supported by many, it is an economically inefficient price floor when viewed from a purely economic perspective. As a result, the statements made in favor of this Minimum Wage Reduction Act all revolve around the concept of economic efficiency and the betterment of society as a whole. Again, from a purely economic standpoint, the reasoning is legitimate. The specifics of this legislation are as follows: the minimum wage is immediately eliminated, workers are required to send 70% of their wages to the government in the form of taxes, and businesses are required to pay a per capita tax for each worker they choose to employ. The first reaction must inevitably be a question asking how the title of the legislation corresponds with its function (how does an act to eliminate the minimum wage also have requirements about large tax increases?). For now, put this aside. Whereas the situation prior to the enactment of the legislation was characterized by some unemployment as a result of the minimum wage, the situation following the enactment of the legislation is likely to be characterized by some unemployment as well, if not more unemployment. Businesses could move out of the country to hire workers for which a per capita tax is not required, and workers might leave the country to avoid paying more than half of their income to the government. As a result, sentiment across the country is such that eliminating the minimum wage, or pro-market reforms in general, do not actually benefit people overall. Returning to the specifics of the legislation, it is clear why the situation post-enactment was precisely as it was. The Minimum Wage Reduction Act was not just about reducing the minimum wage. Moreover, it was not pro-market reforms that caused the exodus of business and labor. But the problem is not so much the misunderstanding of what constitutes a pro-market reform as it is the fact that an anti-market reform was enacted that reduced overall well-being.

ii. Free Trade Area of the American States (FTAAS)

The second metaphor also takes place in the United States. By constitutional mandate, the area among the individual states can be considered a free trade zone. Individual states are not permitted to enact their own tariffs, quotas, or other traditional barriers to trade. Assume this is not the case. Each state may legislate most of its own policies including tariff/quota policy. Suppose New York has developed as an economically progressive state. This means that New York has progressive taxation, high minimum wage laws, laws that benefit the environment, and laws that mandate certain safe working conditions for labor. New York is also very “family-oriented” in the sense that once citizens start families, they move to New York for one reason or another. This is simply a cultural phenomenon. As a result of this, a famous toy company has operated in New York for decades where there is a market for children’s toys. It is a fact that labor in New York is more expensive, but because the location of production and the location of sale is essentially the same, the company actually saves by hiring the more expensive labor. They avoid transportation costs. The company is further protected by New York tariffs which make other toy companies’ toys more expensive for New York consumers to buy. Assume now that the federal government has decided to take the prerogative of dictating trade policy for the states. For simplicity, there is no opposition to this. In particular, the federal government has proposed the Free Trade Area of the American States (FTAAS) because it is universally accepted by economists that traditional barriers to trade are inefficient and that free trade benefits everyone. The stipulations of this legislation are as follows: tariffs and quotas are to be eliminated, and state-specific economic policies with respect to taxes, minimum wage laws, environmental laws, and general business regulations are either to be maintained at their current levels or increased in an effort to promote the harmonization of regulatory laws across the country. As in the first metaphor, the expected reaction is to ask how the purported goal of the legislation squares with the specifics of the legislation (how does a law to reduce tariffs also have requirements about maintaining high regulations?). Again, put this aside. The effects of this legislation are somewhat predictable though other effects are indeed possible. In the short run (before regulations are fully harmonized), the New York toy company will move out of New York and into a state or various states where regulations are less stringent since the company is otherwise forced to compete against other toy companies without a protective tariff. Locations with lower minimum wage laws, lower environmental standards, and the like, are now more important than the distance factor. Now the reality of the situation can be addressed. It is true that the FTAAS reduced barriers to trade, but with the added stipulations, can we say with confidence that the legislation was about freeing trade? The legislation could have concerned itself with only tariffs and quotas thus allowing individual states to alter their own laws for the purpose of competition, but this was not the case.

NAFTA’s preamble summarizes the desires of Canada, Mexico, and the United States for the greater hemisphere. These include strengthening friendships and increasing trade by reducing barriers to trade. Closer to the end of the preamble are such goals as sustainable development, environmental laws, regulations, and worker’s rights. Since the classic definition of free trade is a situation of few, if any, governmental barriers, free trade can also be thought of as minimal government involvement in the market. What is ironic about the goals listed at the end of the preamble is the fact that they entail precisely the opposite of free trade; they require greater government involvement in the market and therefore greater economic inefficiency. Whatever one’s opinion of the necessity of this involvement, it can be objectively stated that this involvement does not fit the definition of making trade free; more importantly this involvement also has real effects on the economy that are not the results of a laissez-faire approach to trade.

This section of the paper will focus on the purely economic tenets of NAFTA pointing out that it is not simply about freeing trade. Article 102 puts forth the objectives of NAFTA. The first of the objectives adheres to the classic definition of free trade. It states, “The objectives of this Agreement… are to: a) eliminate barriers to trade in, and facilitate the cross-border movement of, goods and services between the territories of the Parties…” (NAFTA). Therefore, from a purely economic standpoint the lowering of barriers does indeed bring about freer trade. Article 302 further states, “…no Party may increase any existing customs duty, or adopt any customs duty, on an originating good… each Party shall progressively eliminate its customs duties on originating goods…” (NAFTA). These rules relating to barriers, the movement of goods and services, and customs duties are all naturally trade enhancing; they remove the unnatural existence of government involvement in the marketplace with respect to trade. This instance of the agreement increases the freedom associated with international trade and therefore causes countries to benefit from the division of labor and a more efficient allocation of resources.

The predominant portion of NAFTA is reserved for special circumstances and for elaboration on the rules associated with specific goods/services. For the purpose of brevity, a sample of the remainder is provided here. Article 405 states that, “…a good shall be considered to be an originating good if the value of all non-originating materials used in the production of the good that do not undergo an applicable change in tariff classification set out in Annex 401 is not more than seven percent of the transaction value of the good…” However, this paragraph does not apply to, “…a non-originating material provided for in Chapter 4 of the Harmonized System or tariff item 1901.90.aa (dairy preparations containing over 10 percent by weight of milk solids) that is used in the production of a good provided for in Chapter 4 of the Harmonized System…” or to certain other non-originating material situations. Later, chapter 7 concerns itself with trade-related issues involving agriculture in particular. “The Parties shall work together to improve access to their respective markets through the reduction or elimination of import barriers to trade between them in agricultural goods” (NAFTA). The sections coming closest to establishing free trade discuss the removal of barriers, but nothing more.

Making up a small minority of NAFTA’s inordinate length are the rules that run counter to free trade and negate the idea that NAFTA is truly a free trade agreement. One glimpse of the agreement’s nature is in the manner that government is permitted to interfere in the market. Article 904 states that, “…each Party may, in pursuing its legitimate objectives of safety or the protection of human, animal or plant life or health, the environment or consumers, establish the levels of protection that it considers appropriate…” (NAFTA). As stated earlier, the purpose of this paper is to objectively ascertain whether NAFTA artificially restricts/induces trade or truly promotes free trade. Article 904 appears benign but when considering the dynamics of the countries involved, this section in addition to others has far reaching consequences. By allowing governments to set labor regulations, business costs rise for the countries whose labor regulations are high (United States) relative to countries whose labor regulations are low (Mexico). This affects trade. Empirical data, however, will be discussed in greater detail, later. Moreover, article 1114 applies in a similar manner but instead to the environment. The parties to the agreement “recognize that it is inappropriate to encourage investment by relaxing domestic health, safety or environmental measures” (NAFTA). Requiring a minimum set of business regulations might be deemed necessary by the citizens of a country, but their encouragement in an agreement involving a number of countries will change trade dynamics between them and take away from the free trade aspects of that agreement. Article 904, article 1114, and similar sections in NAFTA take a somewhat permissive approach to positive roles that government may pursue, but NAFTA’s side agreements take a more forced approach. The permissive aspect was discussed here for the purpose of identifying the regulation-increasing and thus cost-increasing elements of the agreement that governments may wholeheartedly practice, a fact which by necessity negates free trade by altering the terms of trade from government involvement.

NAFTA’s side agreements include the North American Agreement on Environmental Cooperation (NAAEC) and the North American Agreement on Labor Cooperation (NAALC). In part 2 of NAAEC, entitled “Obligations,” participating countries are told to, “…further scientific research and technology development in respect of environmental matters… promote the use of economic instruments for the efficient achievement of environmental goals… ensure that… laws and regulations provide for high levels of environmental protection and… strive to continue to improve those laws and regulations” (NAAEC: Part 2). Perfectly parallel to the obligations of the environmental agreement are those of the labor agreement. Each party to the agreement must “ensure that its labor laws and regulations provide for high labor standards, consistent with high quality and productivity workplaces, and shall continue to strive to improve those standards in that light” (NAALC: Part 2). Will stipulations of increased environmental and labor regulation lead to greater economic efficiency along the lines of minimal government involvement in the market? The process of increasing environmental and labor regulations to meet those of the more regulated countries is called “upward harmonization.” The dynamics of this process will be discussed in the next section. The reader is now encouraged to think back to the metaphors outlined in section III to formulate an understanding of how NAFTA measures against the rubric of free trade.

The main tenets of the NAFTA agreement and its side agreements can be summarized as follows: trade barriers and traditional restrictions to trade should be reduced, which is in line with the concept of free trade because government interventions are being removed. Also, a process of “upward harmonization” should be implemented to level the regulatory burden of all the countries that signed NAFTA. This part is counter to free trade because greater government intervention is being mandated. Section V of this paper will first hypothesize on what the effects of a combination of lowered trade barriers and upward harmonization might be. It will then look at studies and analysis of upward harmonization to demonstrate how upward harmonization relates to free trade. In addition, section V will examine anecdotal evidence that includes American business sentiment on the trade debate and the circumstances of a number of businesses since the passage of NAFTA; this is to measure the empirical evidence against the earlier hypothesis. This section will then point to real-life examples of the earlier-added concepts to the traditional definition of free trade, for the purpose of garnering a more broad understanding of the nature of America’s trade aside from NAFTA. Do the passage of NAFTA alone and the results of NAFTA reflect that the United States has been pursuing free trade? Do other American trade policies reflect a desire to pursue free trade? Unfortunately, they all do not. In fact, the elements added to free trade in section II, when applied to the United States, require a more emphatic response in the negative. Finally, section V will admit the limitations to this research and make recommendations for further study.

i. Hypothesis

Since tariffs, quotas, and other traditional barriers to trade unnaturally divide regions where they otherwise would not be divided, the removal of said barriers would just enlarge the size of the area over which goods may pass freely. Trade barrier removal can therefore be considered synonymous with increasing the scope of the territory to which the word “domestic” normally refers (when it is also understood that domestically, economies are relatively free). By extension, goods and capital are permitted to move freely across the greater region. The part of NAFTA concerned with barrier removal is a welfare enhancing policy that moves goods and capital to regions where they are treated best by the market. Before hypothesizing what effects might be observed with barrier removal, it is necessary to address the mandated upward harmonization, also included in NAFTA.

The debate on upward harmonization has focused on whether or not instituting free trade requires the harmonization. This paper agrees with analyses positing the view that free trade is welfare-enhancing in and of itself; free trade does not require policy qualifications to function properly (Bhagwati 168-169). While this question of trade harmonization being necessary to free trade runs parallel to the current paper, it does not deal with the more relevant question to this paper of the short run effects of upward harmonization masquerading as the effects of free trade. Short run here is meant to be understood as the period after upward harmonization is mandated, but before the less harmonized regions are made to be more harmonized (or before the more harmonized regions find themselves in line with the previously less harmonized regions). Again, not only is upward harmonization not necessary for free trade, it is also directly opposed to free trade by its very nature. Claude Barfield of the American Enterprise Institute writes that the creation of “new international bureaucratic regimes to force ‘upward harmonization’ of environmental and social systems is anathema to this philosophy” of free trade (Barfield). The results of NAFTA have not been of free trade; they have been the results of government-regulated trade, but more importantly are not welfare-enhancing as a result.

The decision to institute upward harmonization is an implicit admission that regulatory differentials exist among countries. The specifics of NAFTA prohibit the reduction of labor and environmental regulations, but are silent on the timetable for the upward harmonization to be completed. The side agreements ensure that, “the enforcement of domestic environmental laws and workplace standards and requirements will be strengthened,” and that “no nation will lower labor or environmental standards, only raise them. Of course, all states or provinces can enact more stringent measures” (Kantor). This effectively means that in the short run, higher regulatory regions are forced to compete against lower regulatory regions, the former without the ability to lower regulations in order to remain competitive. To wit, if NAFTA were to only lower trade barriers while remaining silent on all other issues, this paper would offer no objections on the grounds of economic efficiency.

However, NAFTA is instead forcing countries like the United States to compete against countries whose regulatory environments are almost non-existent. With the United States prohibited from redressing the situation by lowering its own business costs, the state of affairs for the United States is one of economic inefficiency, and definitively not one of free trade. At this point, economic theory dictates that with goods permitted to freely move across regions, they will travel to the regions in which they are treated best. Therefore, we would expect that with the passage of NAFTA, capital would flow out of the United States where it is forcibly made expensive, and into countries where regulations are lower.

ii. Anecdotes

It has been established that upward harmonization in the short run combined with the reduction of tariffs, will cause goods and capital to flow away from regions where they are made artificially costly. This paper now turns to the regulatory burden found in the United States. One characteristic of industrialized nations is that they are most progressive in their environmental and labor protections. Merits aside, regulations translate into costs. In the United States, the “costs for small business have dramatically increased over the past decade… High regulatory costs translate into less investment and lower efficiency for all firms” (Kerrigan). This statement applies to small business in particular but can easily be applied to American businesses as a whole, as revealed by a number of studies.

The Ten Thousand Commandments: An Annual Snapshot of the Federal Regulatory State report conducted by Clyde Wayne Crews Jr. is critical to understanding the unnatural burden faced by American businesses that NAFTA solidifies through its stipulations. The author finds that,

The regulatory burden of the United States is clearly no small matter. This is a burden that the entire economy faces, including American businesses. Given the necessity for these businesses to forcibly, under NAFTA, compete against foreign businesses, it is no wonder so many have chosen to relocate overseas where the regulatory environment is less stringent.

One industry cited frequently by protectionists as critical for the economy but one that is also fast-disappearing is that of manufacturing. This paper by no means examines the plight of this industry as an argument for trade protectionism; instead, this paper examines the plight of the manufacturing industry as proof that its move overseas is not the result of free trade. The National Association of Manufacturers issued a report in 2003 called How Structural Costs Imposed on U.S. Manufacturers Harm Workers and Threaten Competitiveness. This report was undertaken because despite productivity gains in the sector over the last two decades, manufacturing has still been unable to compete. Is it because foreign competitors are ceteris paribus more productive and efficient? The report responds in the negative. It states that,

The report goes on to recommend reducing the corporate tax burden, the burden of rising health coverage costs, and numerous other costs specific to the United States in their severity.

One company-specific example of cost differentials is General Motors. In 1996, Canada’s socialized healthcare system permitted GM to avoid paying healthcare costs for its employees. In the United States, healthcare is not socialized but instead the government requires that businesses provide their employees with this entitlement. As a result, GM was saving more than $10 per hour in labor costs and began closing its American plants (Heinzl). Studies of the automobile industry conducted by JM Rubenstein found that an auto firm’s location decision is influenced by situation costs and site costs. The latter include wages, taxes, and amenities (Rubenstein 1986; 1988). Economists might point to these site costs as examples of why it is more efficient to move production overseas. But these costs are not so much cheaper overseas as they are more expensive in America. The reason, once again, is regulation. It is true that given the regulation, it is still more efficient to move overseas, however that begs the question: if the United States wishes to promote efficiency through trade, why not lower its own domestic regulatory burden to have businesses truly produce where they are ceteris paribus most efficient?

Car manufacturers are not the only example. Similar situations have occurred for textiles, plastics, furniture, defense, hi-tech jobs, and countless others. While the “Coalition for Fair Lumber Imports” is more concerned with Canada’s unfair trade practices, its motto is that, “We can compete against any lumber industry in the world, but we can’t compete against their government, too” (Coalition for Fair Lumber Imports). The same holds for other producers in the United States; the only difference is that the government they are competing against is that in their own country. The United States regulatory burden cemented by NAFTA is inefficiently pushing American business abroad.

iii. Even aside from NAFTA, is this free trade?

Theoretical and anecdotal evidence make clear that the United States cannot be considered a promoter of free trade. For the most part, this is because its embodiment of free trade, the North American Free Trade Agreement, is not actually just about reducing tariffs. “Also, just because just because a country is open to international competition doesn’t mean that it won’t meddle in international markets. Complexities (and hypocrisies) abound when countries establish international trade agreements. In this regard, the U.S. and its free-trade friends are deserving of no small amount of shame” (Prescott). At this point, it is helpful to utilize the expanded definition of free trade from section II to investigate some of the meddling in international markets. These include a sampling of funds that flow from the government of the United States into foreign countries, thus bettering the latter at the expense of the former.

In a speech to the World Affairs Council, President Bush discussed a number of issues including the promotion of free trade agreements in 2002. He boasted to have “recently approved $625 million to support these efforts” of “strengthening law enforcement, reducing illegal crops, and expanding legitimate business opportunities” in Colombia and the Andean nations. In addition, President Bush remarked that his next budget would allocate a “nearly $50 million increase in aid to the World Bank programs that assist the poorest countries” and that he would “consider requesting increases over $100 million” if the bank achieved results (Bush). Despite the justification in section II for including such money flows in the concept of free trade, one might still ask, why discuss foreign aid with free trade? The reason is that trade is an entirely theoretical concept. It matters not whether flows to the World Bank are discussed or what types of trade barriers are discussed. For the purpose of trade, it is necessary to discuss the extent to which government is not interfering with it. Any governmental flows from the United States to other countries will have effects on taxes and interest rates, which will in turn have effects on trade.

The Overseas Private Investment Corporation (OPIC) is further proof of significant money flows from the U.S. to countries abroad. A bilateral agreement between the U.S. and Mexico promised to offer all the services for the latter as paid for primarily by the former. With the help of the United States, “OPIC has supported $145 billion worth of investments that have helped developing countries to generate over $11 billion in host-government revenues and create over 680,000 host-country jobs,” in a period of just over 30 years (United States). These countries presumably consist of some of the labor and capital competition that American businesses face. Approximately two years later in 2004, OPIC provided $2.5 million to Indonesian vanilla farmers (Anderson). By eliminating tariffs and quotas, the U.S. does not automatically become an adherent to free trade. In fact, the situation amounts to almost forced business exit from the American economy.

Though there are many examples of American funds flowing overseas at the expense of American businesses (among other interests), the final example here is of the Export Import Bank. In 2004, the Export Import Bank of the United States provided a $652M loan guarantee to support the export by Applied Materials Inc. based in California, for the purpose of building a plant in Singapore. It is ironic that Ex-Im Bank Chairman Philip Merrill justified the action with the statement that, “It is important for Ex-Im Bank to help U.S. manufacturers of high-technology equipment to remain competitive in key markets” (Ohe). Government intervention in trade does not help companies remain competitive; it artificially keeps them afloat in an uncompetitive manner. Oddly, there are many examples such as those provided here that illustrate how the U.S. supports businesses and entire countries abroad, and supports agreements like NAFTA that do not actually promote free trade. Since the former is itself not free trade, and NAFTA as an agreement is not just about reducing tariffs, it cannot be stated with certainty that the United States is an adherent to free trade. The situation of the United States is therefore one of economic inefficiency.

iv. Limitations and Recommendations

There are limitations to this paper that fall on the side of empirical evidence rather than on the side of theory. That businesses might relocate overseas in response to overbearing regulation is theoretically sound, but that this hypothesis is proved with certainty from a number of anecdotes, is not definitive. Levinson makes this point clear: “Although there seems to be plenty of anecdotal evidence that policy makers and industry representatives take industrial flight seriously, there is only a limited amount of empirical evidence that industrial flight exists” (Levinson 433). Over a decade since the passage of NAFTA, the anecdotal evidence of industrial flight has ballooned, but the formalized proof in econometric studies is still wanting. Research needs to proceed to answer the questions: Has industrial flight from the United States systematically occurred? And if so, is this a result of tariff reductions, domestic regulations, or a combination of both? Incidentally, the results might alter the reasons for capital flight, but they do not alter the fact that the U.S. does not promote free trade by being a partner to NAFTA and by exporting funds to foreign countries for various purposes.

Another limitation of this paper is in its qualitative rather than quantitative approach to measuring how free American trade is. Qualitatively, one may point to reductions in tariffs/quotas as trade-enhancing and domestic regulation and money flows abroad as trade-restricting, but it is not numerically clear which policies gain the upper hand. Despite the domestic regulatory burden that NAFTA imposes, have the tariff reductions been significant enough to offset the losses from the regulations? Also, while it is theoretically possible to calculate this in the short-term, research would benefit from models that calculate the potential long-term effects of NAFTA. For instance, the tariff reductions might quantitatively reduce the welfare-destroying regulatory burden, but how high might the regulatory burden become, decades from now? Might NAFTA be amended to freeze at a minimum the money flows in the expanded trade definition that the U.S. exports to foreign countries? How will this alter the gains/losses from NAFTA’s tariff reductions? Though the expanded definition of trade includes many economic policy factors that influence the dynamics of trade, at least quantitative research into the more major trade-influencing policies should be explored. Furthermore, the current expanded definition of trade is in a primitive state. For the purpose of complete economic theory, other trade-influencing policies should be elaborated upon as well.

The United States should pursue free trade because it is welfare-enhancing. This means lowering tariffs in addition to the regulatory burden imposed on American businesses. It also means that foreign flows for the benefit of other countries at the expense of the United States should be reduced. Until many of these criteria are met, not just tariff and quota reduction, it is difficult to conclude that the U.S. is pursuing free trade. This paper has expanded the definition of free trade which has permitted the reader to view all the aspects of American trade that are not free. The metaphors helped reveal the nuanced concept of upward harmonization whose results are not as obvious as that of tariff reduction. The debate over NAFTA is misleading with proponents arguing in favor of free trade and opponents arguing against free trade. A more accurate debate over NAFTA would be whether or not the agreement concerns free trade in the first place; then, the observed results of NAFTA would make more sense empirically. As already stated, the United States would do well to follow free trade, but the current policies are not those of free trade when examined closely. At least for now, it appears that the U.S. is subsidizing the world, taxing itself, and claiming to be an adherent of free trade all at the same time.

















United States. U.S. Embassy in Mexico City. US and Mexico Sign Bilateral Agreement Paving Way for Full OPIC Activity. <http://www.usembassy-mexico.gov/texts/et030609opic.htm>.

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4 Comments:

At Tue Mar 18, 08:21:00 PM EDT, Anonymous Anonymous said...

quite informative and interesting if I say so myself.

 
At Tue Mar 18, 09:18:00 PM EDT, Blogger Cam said...

"Qualitatively, one may point to reductions in tariffs/quotas as trade-enhancing and domestic regulation and money flows abroad as trade-restricting, but it is not numerically clear which policies gain the upper hand. Despite the domestic regulatory burden that NAFTA imposes, have the tariff reductions been significant enough to offset the losses from the regulations?"

This is all I'm saying. Research needs to done to establish the extent of the trade-off. I'm of the opinion that the trade-off is positive in terms of economic liberty, although agreements like NAFTA may prevent regulatory competition in the long-run, therefore increasing intervention. But most empirical evidence on globalization (i.e., "the race to the bottom" or 'top' in our opinion) and government growth/regulation finds little link.

I guess my view is that empirically, freer trade among democratic governments, for political economic reasons, requires the illusion of social protection (i.e., the concept of 'embedded liberalism'). With the impossibility of convincing enough individuals to support libertarian principles, this may be the only way.

Good paper by the way :)

Something else on compromising principles, I'm curious to hear your response to this hypothetical situation (or real situation according to many social historians):

The relative laissez-faire of the 19th century in britain and the us are often seen in idealized terms by libertarian thinkers as the budding of what could have been a utopian liberal world order (myself included at times). By the end of the century however, collectivism was on the rise, with state intervention increasing in almost every aspect of private life. This collectivism was paternalist conservative however, and often a direct response to concerns about the emergence of socialist politics or worse, communist revolution. Conservative collectivism (Disraeli, Chamberlain, Roosevelt, etc.) aimed to provide social gurantees to the masses and promote nationalism, but wanted to defend the principle of private property. Let's call them the ultimate compromisers. They were quite hostile to the Cobdenite, Jeffersonian political ideology that I cherish.

But what if without these 'concessions' to appease the masses, we would've had a communist revolution? Now one can easily argue this wouldn't have happened. But what if? What if compromising was the only way to stave off a Leninist dictatorship? Insisting on not compromising (the camp I probably would've been in if I was around at the time) would therefore bring about something far worse than the compromise. What to do?

I expect that you'll say compromising on this opens the door to this way of defending every statist policy since then (i.e., Keynes, etc.). But would we be better off?

Alan Greenspan said it best: "compromise is the price of civilization"

 
At Mon Mar 24, 11:43:00 PM EDT, Blogger TAYLOR said...

Cam,

Of course the answer to your question seems obvious given the omniscient context in which it is asked, "What if compromising is the only way to stave off a Leninist dictatorship?" and it is known that without compromise, you're guaranteed to have one. Then of course the answer is to compromise. Given THAT context, my strict adherence to principle is not only pointless (it won't convince anyone of anything), it's a deathwish besides.

But that's the problem with the context of your scenario... it's far removed from reality, in a number of ways. I actually had an economics professor back in college who tried to make a similar point to me, but he didn't state it as a theoretical question but rather made it clear this was his belief about the "practicality" of politics. I don't know if this will format correctly on here but he was looking at it like this:

[F------------------A] where F is freedom and A is authoritarianism. He claimed we were somewhere like [F---------|---------A] or so and I said fine, and that the country (US) started closer to [F---|-------------A] following the revolution. He cited FDR's New Deal and such as something that, yes, moved us ->A, but that we had "dug our feet in" at that point so to speak. I made two points to him... 1.) politically, the country had moved further "right" on the F-A scale since the New Deal, so we had not in fact "dug our feet in" as he had claimed, and 2.) perhaps the intent of the compromise was to dig our feet in and keep us from going all the way to A, but a move towards A of any magnitude is a failure from the standpoint of trying to be closer to F... sure, you're not at A, but you are closer to A, and which is preferable, being closer or farther from A?

I have trouble seeing the battle as far as the public's conception of it as being between F and A... look at the political discourse recently and the platforms of the three major candidates (McCain, HilDog and Obama), and you tell me which of them frame the debate as compromising to remain close to F? No, they're all discussing how much and how quickly we should move towards A. F is largely absent from the debate, and A is still, for the time, officially deploreable as an extreme, although variants of it (the half of the scale closest to A) are all acceptable.

Just a bit more on this issue of compromise using FDR, Chamberlain, Churchill etc. as the backdrop... these were not men who were about preventing a communistic dictatorship. I think people by and large knew the risks of ACTUAL communism and were for the most part against it back then. Any threat of the establishment of a communistic majority in those countries at the time was a propaganda effort by FDR, Chamberlain/Churchill etc, if it was felt at all. Remember, communists had always been political minorities in the "Western" countries, but not even just that... they were a minority in the country they first succeeded in! Despite their "Majority" name, the Bolsheviks never had a majority in Russia and acceded to power through corruption and subterfuge. Furthermore, they were assisted in their efforts by FDR and the gang and much of the Western banking and business establishment. I mean the World Communism threat was a farce from the get go, entirely fabricated and foisted upon the world in an artificial fashion.

FDR and Churchill were power hungry fascist maniacs (I DO NOT use the word fascist lightly, I mean this sincerely in both the political and economic senses of the word) and they did what they did because they WANTED to, not because they were trying to save the world from communism.

Look at the history of the world, look at the history of political compromise, and notice that we are slowly but steadily (and sometimes quickly and erratically) venturing further and further from F and closer and closer to absolute A. Whatever your level of skepticism/cynicism, at SOME POINT you have to stop and wonder, "Is this all an ACCIDENT that things are as authoritarian as they are?" In other words, let's stop giving people so much credit for intent and start being a bit more critical of results.

This is a longish read but an EXCELLENT one on the topic of FDR and the New Deal and whether or not it was meant as a defensive compromise or not, by the wise Old Right journalist Garet Garrett: The Revolution Was, by Garet Garrett

Finally, in response to your Greenspan quote...

Greenspan, as former Fed Chief, was a man with almost primary responsibility for destabilizing and undermining "civilization" as we know it. As head of the Fed, he was also the man in charge of the institution which has been responsible for more de-civilizing, barbarous acts (such as 3rd World debt slavery subsidization and perpetual war-financing) than anyone in recent history.

The ironic thing about the compromise he speaks of is that he and other people doing the compromise never pay the price themselves (the politicians that is), and the result, as I hinted at above, is not exactly what I'd call "civilized" in the first place.

Then again, maybe that's the point...

 
At Mon Mar 24, 11:51:00 PM EDT, Blogger TAYLOR said...

Damn, I know the Russian Revolution was in 1917... that FDR/Churchill stuff will sound confusing because they were in the late 20s and 30s. I meant Wilson and the other people in power around the time of the RR helped the Commies get into power, and that FDR/Churchill played along after the USSR was established.

For instance, all the grain shipments and lending of technology and materials and equipment (which was never returned or paid for, of course) by the US/Great Britain/Western Europe to the USSR all throughout their history which was the primary reason it took decades for their to be a collapse of such a nonsensical economic and political regime. You can make all kinds of harebrained schemes work if you have an outside subsidy provider. Without the subsidy, these systems would quickly collapse on their own.

So, my point then was that far from guarding against this type of thing, many prominent people in the US/West were COMPLICIT in supporting it all.

 

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