There's Trade, and Then There's Good Trade

U.S. deals with other rich countries are fine. China is the problem.

If you want French wine, you have to trade for it.

Photographer: Boris Horvat/Getty Images

I find myself in an odd position right now. Having spent years criticizing the elite consensus in favor of free trade, I now am very reluctant to join the backlash.

One simple reason is that the backlash is being led, in part, by Republican presidential candidate Donald Trump and I'm disinclined to sign onto a movement of which he is a prominent leader.

But just as a stopped clock is right twice a day, there is a possibility that Trump is actually right on this issue. After all, he is basically in agreement with Democratic presidential candidate Bernie Sanders about the evils of free trade. The opposition therefore stretches across ideological boundaries. Also, many smart economists whom I respect are now breaking with the erstwhile orthodoxy and coming out against further trade agreements. For example, here is Paul Krugman:

Much of the elite defense of globalization is basically dishonest: false claims of inevitability, scare tactics (protectionism causes depressions!), vastly exaggerated claims for the benefits of trade liberalization and the costs of protection, hand-waving away the large distributional effects that are what standard models actually predict...the elite case for ever-freer trade is largely a scam, which voters probably sense...Ripping up the trade agreements we already have would, again, be a mess...But it is fair to say that the case for more trade agreements — including TPP, which hasn’t happened yet — is very, very weak.

Krugman is right about the sins of the elite consensus on free trade. But, just like Sanders, Trump and most current critics of trade, he ignores what I think is an important distinction -- the difference between free-trade agreements with rich countries and those with less-developed ones.

QuickTake Free Trade Feud

Basically, opening up trade with poor countries such as China can be dangerous. But liberalizing trade with rich countries such as Japan, South Korea and those in Europe has very little potential downside.

The main danger from free trade is the so-called distributional effect. Opening up trade with China put U.S. workers directly in competition with Chinese workers who could do a similar job for much less money. That acted to the advantage of U.S. multinational companies that shifted factories to China, because U.S. companies were the ones with the capital to invest in new Chinese factories. But that hurt U.S. workers who were suddenly out of a job. Many manufacturing industries shifted to China and many laid-off U.S. workers were forced to take low-paying low-skill jobs, while others simply dropped out of the labor force. Trade with China has been great for rich Americans, but it's been a disaster for much of the working class.

But when the U.S.'s trading partner is Germany, or Japan or France, little danger exists. A Japanese factory worker makes about the same as an American factory worker. Furthermore, Japan has just about as much physical capital per worker as the U.S. This means that when Japan competes with the U.S., it doesn’t work to the advantage of rich capital owners or put pressure on U.S. workers’ wages.

So why does the U.S. trade with Japan or France or Germany in the first place? Actually, Krugman’s own Nobel Prize-winning research explains the reason. When rich countries trade with each other, they can increase variety. Instead of only buying cars from General Motors and Ford, we can also get cars from Toyota and Honda. That means you can buy a big gas-guzzling SUV if you want, or a little efficient hybrid. Imagine a world without French wine, German loudspeakers or Japanese video games. That’s the world you get when you choke off trade between rich countries.

There are other benefits of trade between rich countries that go beyond Krugman’s model. When companies in rich countries compete with each other, they often become more productive. They invent new processes and technologies, making their workers more productive and ultimately increasing wages. Economics writer Adam Ozimek points to some research showing this. (In fact, trade with poor countries also has this positive effect, though it has to be weighed against the aforementioned risks to U.S. workers.)

So there’s really very little for Americans to fear from trade with other rich countries. And which countries is the U.S. considering for expanded trade? Mostly rich ones. The Transatlantic Trade and Investment Partnership is an agreement between the U.S. and the European Union. The Trans-Pacific Partnership contains two poor countries (Vietnam and Peru), but the main treaty partners are rich or middle-income countries, including Japan, Canada, Australia and the like.

Does any rational person think that trade with Europe, Japan, Australia or Canada is a threat? Trump certainly does, though he's wrong. Trading with these countries -- which also happen to be some of the U.S.'s most important geopolitical allies -- will help American workers, not hurt them. The protectionist backlash is a reaction against the most harmless form of trade. That needs to change.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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