Understanding The Complexities Of Free Trade

Published on August 15, 2018

By: Michael Busler
ClashDaily Guest Contributor

While we are in the midst of the “great trade war of 2018”, it may be a good time to fully examine our trade policy so we have a clear view of the goals. The general conclusion by the vast majority of economists is that free trade is a net positive and should be encouraged. It is not, however, totally positive.

The basic concept showing the benefits of free trade is relatively easy to see.

If the US decided to grow wheat and coffee, we would find that we are extremely efficient at producing wheat. That means we get large amounts of output utilizing just a small amount of our resources. But the US is extremely inefficient at producing coffee, meaning we would use a ot of resources and not get much output.

A country like Columbia, in South America, is exactly the opposite. They are extremely efficient at producing coffee, but terribly inefficient at producing wheat. The simple solution is to specialize and trade.

So the US grows the wheat. Columbia grows the coffee. We trade and both countries end up with more wheat and more coffee. And at the lowest possible cost.

It gets a bit more complex in the global market, especially when a country enters for the first time. The steel industry, for instance, has been hurt by foreign producers, like China. Because of their extremely low wage rates and abundance of labor, they produce steel at a much lower cost than US producers.

Even with that, the US can produce steel at a competitive price. So, to gain an advantage, the government of China subsidizes the steel industry, which means the government pays part of the production cost. China also decides to set the exchange rate of their yuan, so it is very inexpensive to buy with US dollars.

The result was that inexpensive steel from China was purchased for US factories. This coupled with lopsided trade deals decimated the US steel industry.

While this situation offers the most steel to the US market at the lowest price, it does create abandoned factories and high unemployment in the steel industry. In theory, economists argue that resources no longer utilized, are free to be used for other goods where the US has an advantage. In reality, though, factories lay empty for years.

In addition, we coined the word dumping, which became an illegal activity. Dumping occurred when a foreign company sold their products in the US consistently below their cost with the apparent goal of driving the competition out of business. With a subsidy the foreign firms could sell below cost.

Noted economist Milton Friedman, very emphatically, always said that if a foreign government wants to subsidize an industry to lower the cost to the American consumer, we should take all they are willing to give us. In effect, they are subsidizing our consumption. It keeps our prices low and that improves our welfare.

President Trump is a firm believer in free trade. His ultimate goal is to renegotiate all trade deals and eliminate all tariffs. His current strategy is to create a sense of urgency with our trading partners so that they will quickly come to the bargaining table.

Consistent with his negotiating style, Trump likes to start from a position of strength. He also wants the trading partners to willingly come to the negotiating table as quickly as possible. While that may be difficult for a politician, it is simple for a businessperson.

Quickly seeing that the US trade deals were so lopsided, he knew the trading partners would be very reluctant to renegotiate. Trump also knew that our trading partners’ economies relied more heavily on the US than the US relied on them.

To achieve his goals, the President imposed heavy tariffs on foreign-made goods. This put the US in a position of strength and created a sense of urgency with our trading partners.

Most countries have retaliated. This may, unfortunately, cause short-term pain for some US firms who rely on exports. But in only a few months, the tariffs have brought many countries and the European Union to the bargaining table. The rest will follow shortly.

In the end, Trump will end up with free and really fair trade. No longer will US companies feel like they are playing in a baseball game where we get three outs per inning and we give our trading partners four.

Trump, however, will have to confront the negatives. What happens when factories close? What happens to the unemployed who may not be easily retrained? What happens when a foreign government decides to subsidize the American consumer? Should dumping be illegal?

Michael Busler, Ph.D. is a public policy analyst and a Professor of Finance at Stockton University where he teaches undergraduate and graduate courses in Finance and Economics.