The aphorism “A rising tide lifts all boats” has become entwined with a basic assumption that free trade results in economic wins for all players in the global economy. Of course this assumes you are lucky enough to have a boat that has not run aground.
The classic case for free trade was made nearly 200 years ago by economist David Ricardo. This static argument relies on the principle of comparative advantage; that trade enables countries to specialize in goods and services they produce more efficiently than do their trading partners. This increases overall productivity and total output.
The conclusion follows from countries having different opportunity costs of producing tradeable goods. The opportunity cost of any good is the other goods that could have been produced by the same resources. Each country focuses on what it does best and everyone gains. This notion of free trade has a hallowed status among the cheerleaders for globalization.
Another way to understand comparative advantage is to consider the opportunity cost of undertaking a certain activity. Let’s assume that Lady Gaga, the famous entertainer, also happens to be a world-class typist. Rather than entertaining and typing, she should specialize in entertaining, where her comparative advantage is greatest and she could maximize her income.
In this example, Lady Gaga has a much higher opportunity cost of typing than does her secretary. If Lady Gaga spent an hour typing while the secretary spent the hour running the business, there would be a loss of overall output.
The real world is much more complex. Free trade has a downside: while its benefits are broadly distributed, costs are often concentrated. Consider the case of American textile workers. In the aggregate, American consumers gain by having access to cheap clothing, but unemployed textile workers bear the loss.
Many free trade cheerleaders confuse it with off shoring jobs, which is simply substituting, cheap foreign labor for more expensive American labor when nothing is in fact being traded. Moving production overseas has nothing to do with comparative advantage; it simply reflects wage and price competition from countries seeking jobs and economic growth.
If a firm shifts production to low-wage countries, its profits improve, driving up share prices and senior management performance bonuses. To paraphrase one-time presidential candidate Ross Perot: If you can build a factory overseas, pay about a dollar an hour, have little or no health care or retirement benefits and no environmental controls, then you are the greatest businessman in the world
But when many firms move overseas, American workers lose their incomes. So when do the costs of lower incomes resulting from job losses and government revenues exceed the benefits to consumers of lower prices? Put differently, do the costs of exporting good-paying American jobs outweigh gains from cheaper imports and contribute to a shrinking middle class.
Free trade advocates contend that the Americans left unemployed have acquired new skills and will find better jobs in “sunrise” industries. In reality, how many steelworkers do you know who have become computer software engineers?
This is one reason why Americans’ real incomes have stopped growing as manufacturing jobs have been moved offshore.
As then-presidential candidate Barack Obama said in 2008, “You go into these small towns in Pennsylvania and like a lot of small towns in the Midwest, the jobs have been gone now for over 25 years and nothing’s replaced them. And it’s not surprising, then they get bitter, they cling to guns, or religion or antipathy to people who aren’t like them or anti-immigrant sentiment or antitrade sentiment to explain their frustrations.”
A former General Motors CEO allegedly said “what is good for GM is good for America.” But offshoring challenges the conventional wisdom that American firms generally advance the nation’s economic interests. When they employ a large foreign workforce but few people within the United States, it certainly is good for the firms, but not for the American worker.
Originally Published: April 16, 2016.
