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Saving free trade

By Peter Morici
web posted January 22, 2007

Free trade is under siege. The Doha Round is failing, China’s success is encouraging other developing countries to experiment with state-managed capitalism, and newly elected Democrats in Congress are questioning U.S. allegiance to open trade.

This is a tragedy, because no public policy can create wealth quicker than free trade based on comparative advantages. However, these benefits will be realized only if the rules, established by the World Trade Organization and other international agreements, are enforced. Sadly, presidents, back to Ronald Reagan, have been reluctant to assert U.S. rights, and the system is spinning out of control.

The idea is simple. Let each country export what it makes best and productivity rises everywhere. For example, the United States sells $1.5 trillion in exports, annually, and these finance imports of like amount. Moving workers from export to import-competing industries increases GDP about $160 billion, because workers are about 10 percent more productive in export industries than import-competing industries.

Unfortunately, U.S. imports exceed exports by $800 billion, and workers released from making those additional imports go to industries that do not compete in trade, where productivity is at least 50 percent lower. This slashes GDP by $400 billion to $500 billion. Hence, free trade, coupled with a huge trade deficit, reduces GDP at least $250 billion.

Professionals at multinational corporations, banks and law firms that manage globalization enjoy big incomes; however, those benefits are dwarfed by costs borne by workers who lose good jobs to imports, don’t move to export industries, and wait on tables.

Americans feel richer, even as some suffer, because the Chinese and other foreigners lend them about $50 billion each month to finance the trade deficit, and consume more than they produce. The accumulated debt is about $6 trillion, and the annual debt service is about $300 billion. When credit runs out, living standards will tank.

Many factors, including the federal budget deficit, create the trade deficit; however, the budget deficit is less than 2 percent of GDP and can’t solely instigate a trade deficit exceeding 6 percent of GDP. The rest of the problem is not hard to find.

Through currency market intervention, China significantly undervalues the yuan, and Ben Bernanke has labeled this tactic a subsidy. This intervention exceeds $200 billion, annually, or about 25 percent of the value of its exports.

Other Asian governments follow similar currency strategies, and with China, deploy aggressive industrial policies that subsidize exports and limit imports. Together, they are racking up annual trade surpluses with the United States of about $400 billion.

WTO rules permit the United States to precisely offset with duties the subsidies exports receive from governments. When applied, these ensure that comparative advantages, not mercantilist policies, motivate exports.

Since 1984, the Commerce Department has refused to address subsidies in non-market economies. Hence, China, the largest offender, can offer incentives to exporters that Canada, Chile or France cannot without a U.S. response.

Further, the Treasury, which oversees U.S. currency policy, does not acknowledge that China manipulates the yuan to gain competitive advantages. Apparently, the economists at Treasury had different training than Ben Bernanke.

Ending special treatment for Chinese subsidies would reduce the trade deficit, and applying subsidy laws to currency manipulation would reduce it a lot.

Similarly, internationally recognized labor standards, like those prohibiting child and forced labor, are widely flaunted in Asia, lowering labor costs and boosting exports beyond those dictated by comparative advantages. Also, lax environmental enforcement abroad disadvantages U.S. manufacturers much like a government subsidy.

WTO law permits the United States to exclude imports made in ways that damage the environment if the practice violates an international environmental agreement and the United States imposes equally reasonable standards on domestic and foreign producers. For example, the WTO Appellate Body upheld a U.S. prohibition on imported shrimp caught in ways that harm sea turtles, which are protected by the Convention on International Trade in Endangered Species.

The United States should be able to exclude imports made by child labor or workers denied basic rights under International Labor Organization Conventions.

Domestic manufacturers and organized labor have asked the Bush Administration to address Chinese subsidies and currency manipulation, and lax enforcement of labor and environmental standards, but it has not.

Many Democrats believe labor and the environmental rules should be directly written into trade agreements, but that won’t do any good if the President won’t enforce the rules.

The United States does not need new agreements as much as it should assert U.S. rights under existing agreements.

Then trade would be based on comparative advantage, and no one should complain about having to compete on those terms. ESR

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.

 

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