WASHINGTON, April 26, 2015 − President Obama is on the verge of signing an historic trade agreement with 11 Pacific Rim countries, a list that includes both Japan and Singapore. This Trans Pacific Partnership (TPP) will allow trade among these nations without longstanding burdens like tariffs, quotas or special duties. This agreement will greatly benefit the majority of Americans. Yet many oppose the TPP.
Economists almost uniformly agree on the positives of free trade, perhaps with the exception of labor economists. Using what they refer to as the Theory of Comparative Advantage, their studies clearly show that when countries specialize in what they can produce most efficiently and then trade for the other products, they end up consuming more than they would otherwise produce. How is this possible?
Suppose we select two countries: the United States and Colombia. Now, we select two products: wheat and coffee. Primarily because of local climate conditions, the U.S. is very efficient at producing wheat while Colombia is efficient in the production of coffee.
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Using all of the resources available for these two products, the U.S. finds it can produce them at two points: one where the U.S. can get nine tons of coffee and 84 tons of wheat; or another where the U.S. can produce just wheat and can get 120 tons of that commodity.
Similarly, the smaller country of Colombia can produce these commodities at a point where they get nine tons of coffee and 33 tons of wheat; or another where they can produce just coffee and get 20 tons of it.
If these countries do not have free trade, they produce at the first point, in order to assure adequate supplies of both coffee and wheat. However, suppose they sign a free trade agreement. Then each country specializes in what it produces most efficiently and abundantly. The U.S. would produce only wheat, while Colombia would produce only coffee. The free trade agreement also sets the terms of trade at 10 tons of coffee for 35 tons of wheat.
Colombia now decides to choose the second option. They produce 20 tons of coffee and trade 10 to the US. In return they get 35 tons of wheat. Thus Colombia now has 10 tons of coffee and 35 tons of wheat. This 10C/35W combination is higher than the 9C/33W they would have had without free trade. So Colombia is better off.
Under the same agreement, the U.S. makes a decision to produce no coffee. Instead, the country produces 120 tons of wheat and trades away 35 tons, retaining 85 tons. The U.S. gets 10 tons of coffee in return. Thus the U.S. now has 10 tons of coffee and 85 tons of wheat. The 10C/85W combination is higher than the 9C/84W they would have had without the trade. So the U.S. is better off.
With the trade agreement in place, both countries are able to consume more than they would have been able to produce without the trade. The greater output means a higher standard of living for the people in each country. Everyone wins. Well, almost everyone wins.
Why do some people object to free trade?
Historically, many members of the president’s own party strongly object to free trade agreements. They cite studies suggesting that free trade has resulted in lower wages for workers, especially low-skilled or unskilled workers. Other studies conclude that up to 25 percent of the job loss from 1990 to 2007 was caused by competition from Chinese imports.
In the example above, while the country as a whole benefits from free trade, there is a “structural” unemployment problem that results. In the U.S., the workers who produced coffee would be without jobs and may lack the skills necessary to participate in the production of wheat. This incentivizes wheat producers to automate to increase wheat production, thus further 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 such individuals are in the later stages of their employment careers, rendering re-training not only difficult but unlikely to result in employment at the employee’s previous pay level, if at all.
Still, by being able to consume more goods and services and by having the products made at a much lower cost, the majority of Americans as well as the majority of people in trading partner countries experience a higher standard of living. Since less than 30 percent of our GDP comes from manufacturing goods (the other 70 percent is from providing services), imports from free trade partners have improved the standard of living for the vast majority of Americans.
We should recognize that a structural unemployment problem exists and will worsen as more free trade agreements are signed. But the benefits of free trade far outweigh the costs. So let’s get the Trans Pacific partnership signed and settled.