Understanding the clear benefits of free trade

Understanding the clear benefits of free trade

Donald Trump, Ted Cruz, Hillary Clinton and Bernie Sanders say they will fix this by restricting free trade, perhaps by imposing tariffs on goods produced outside the U.S. But do they really see the whole picture?

Singapore business district skyline. (Image via "free trade" entry in Wikipedia, GNU license 1.2)

WASHINGTON, March 12, 2016 — Candidates from both political parties continue to emphasize the number of manufacturing jobs lost because of free trade with countries like China and Mexico. One study says that between 1900 and 2007, more than 1.5 million manufacturing jobs were lost due to free trade.

Donald Trump, Ted Cruz, Hillary Clinton and Bernie Sanders say they will fix this by restricting free trade, perhaps by imposing tariffs on goods produced outside the U.S. The problem is that the candidates, and most Americans, do not understand the benefits of free trade.

The negatives of free trade are easy to see. Jobs are lost, factories are closed and American consumers purchase billions of dollars worth of goods produced outside the country. Cities that were dependent on the manufacturing sector for jobs experience extremely high rates of unemployment. When the manufacture of automobiles was moved from Detroit to Mexico and overseas, the city was eventually forced into bankruptcy.

But the benefits of free trade, which far outweigh the negatives, are much more difficult to see. Here’s an example:

Suppose we select two countries: the U.S. and Colombia. Next, we select two representative consumer products: wheat and coffee. Primarily because of climate conditions, the U.S. is very efficient at producing wheat while Colombia is very efficient at producing coffee.

Utilizing all of the resources available for these two products, the U.S. finds it has two options. One, the U.S. produces both products and gets nine tons of coffee and 84 tons of wheat per year. The second choice is to specialize in just producing wheat. At this point the U.S. can produce 120 tons of wheat per year.

Similarly the smaller country of Colombia can produce nine tons of coffee and 33 tons of wheat or can specialize and produce just coffee and get 20 tons.

If the countries do not have free trade, each country produces at the first point.

Without trade:

                              Wheat                          Coffee

Columbia                     9                                  33

U.S.                              9                                  84

Total                           18                                117

However, suppose they sign a free trade agreement. Then each country specializes and produces what it does best. The U.S. produces just wheat and Colombia produces just coffee. The agreement also sets the terms of trade at 10 tons of coffee for 35 tons of wheat.

When specializing Colombia produces 20 tons of coffee and trades 10 to the U.S. Per the agreement, it gets 35 tons of wheat.

The U.S. produces 120 tons of wheat and trades away 35 tons, leaving 85. The U.S. gets 10 tons of coffee in return.

With trade:

                                Wheat                          Coffee

Columbia                     10                                35

U.S.                              10                                85

Total                            20                               120

Notice that both countries are better off specializing in what they do best and then trading for other goods.

With the trade agreement both countries are able to consume more than they would have been able to produce. The greater output means a higher standard of living for the people in each country.  Everyone wins. Well, almost everyone wins.

In the example above, while the country as a whole benefits from free trade, there is a “structural” unemployment problem. In the U.S. the workers who produced coffee would be without a job and may lack the skills necessary to produce wheat. This causes wheat producers to automate in order to increase wheat production, thus reducing the need for additional labor.

The opponents of free trade want to protect the jobs of the displaced workers. They do have a legitimate concern that must be addressed, especially in the case where a worker is in the later stages of his or her career and retraining is difficult.

The politicians have a solution. Place a tax on imported goods. They argue this will raise the price and allow American companies to compete. The poor result of that action would find consumers paying higher prices and the country moves back to not specializing. This means fewer goods available to consumers and higher prices.

While a couple of million workers may benefit, hundreds of millions of consumers lose. Since ours is a system based upon what is best for the majority, without infringing on the basic rights of anyone, import taxes should not be considered. Besides, this would likely lead to an international trade war where everyone loses.

Trump is right that countries like China manipulate their currency so that their goods are less expensive in the U.S. The solution would be to have a trade agreement whereby China agrees to let its currency float as almost every other country does. The solution is not to discourage free trade.

It is easy to see the negatives of free trade. The positives are more difficult to explain. But spending only $600 for a smartphone instead of $1,800 — which is what the phone would cost if all components were made in the U.S. instead of China — gives consumers $1,200 more to spend on other goods. This stimulates growth, raises the standard of living and allows more people to purchase smartphones.

While we need a plan to deal with the displaced workers in this country, restraining free trade in pursuit of this aim clearly causes more harm than good for most American citizens.

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