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This is The Problem With Free Trade

Economics / Global Economy Feb 25, 2016 - 12:23 PM GMT

By: Rodney_Johnson

Economics If you join a poker game and can’t identify the “mark,” then chances are, you’re it! The “mark” is the person at the game who is less experienced, or perhaps is given to reckless betting. By including this player in the game, everyone else has an opportunity to walk away a winner.

But don’t lose sight of the bigger picture. Not everyone is a winner, and typically someone ends up the big loser!

The same principle works when countries get together for free or open trade. Everyone talks about how great it will be, how much their economies will grow, about efficiencies and new opportunities. But they almost never talk about the people who will lose.

Believe me, there are always losers.

Adam Smith’s famous book The Wealth of Nations laid out the case for free trade. If one nation is really good at making shoes, and another is really good at making cloth, then when they exchange goods the shoemakers can focus on what they do well and so can the weavers.

In this exchange, the cobbler nation shouldn’t make cloth and the weaving nation shouldn’t make shoes. By specializing on what they do best, each nation can better hone its skills while enjoying a bigger market for its product as well as have access to better goods from abroad. Everyone wins, right?

Wrong. Everyone benefits, but some still lose.

Specialization is at the heart of free trade. Companies that are really good at something should do more of that, using their abilities and resources to be as productive as possible. If they don’t have to work on a bunch of other things at which they lack expertise, then companies can boost their efficiency.

At the same time, consumers in each country benefit from greater selection and, presumably, lower prices. Ideally specialization allows companies and countries to lower costs of production, thereby offering clients better goods and better deals.

So countries win, companies win, and consumers win. But then there is the pesky case of displaced workers.

The weavers in the country of cobblers are now out of a job, as are the cobblers in the country of weavers. In Adam Smith’s version of the story, this is no problem. Obviously the newly-unemployed workers will be quickly hired by companies in their home country that suddenly have an abundance of orders to fill from overseas.

Maybe that was true in Adam Smith’s day.

It’s possible that in the late 1700s, before the industrial revolution created the lands of plenty, such specialization by country created tremendous new selling opportunities for both countries so worker displacement wasn’t a problem. But in the 21st century, we’re not so lucky.

From 1990 to 2013, China’s share of exported manufactured goods on the planet grew from 2.3% to 18.8%. In some areas of American life, Chinese market penetration neared 100%. And if it wasn’t just the Chinese, it was a combination of foreign manufacturers.

Chances are, the computer screen you’re looking at right now was made in Taiwan or South Korea. Even the ones that say “Made in U.S.A.” typically have parts made overseas and just undergo final “assembly” here.

There’s no doubt that by opening their doors to labor and becoming the low-cost workforce on the planet the Chinese government dramatically improved the lives of its citizens.

Since 1990, the average real income in China rose from 4% of its American counterpart to 25% today. As we paid them to make disposable consumer goods, we gained access to cheap stuff, which improved our overall standard of living.

But it came at the expense of jobs. Because of the size of the Chinese labor force and its ability to take over entire industries, giant swaths of manufacturing employment in the U.S. were obliterated. According to a study by Dorn, Autor, and Hanson, 44% of the manufacturing decline in the U.S. between 1990 and 2007 can be attributed to the rise of China. A $1,000 rise in Chinese exports in an affected industry drove down per-worker wages by $500, and government subsidies (retraining, etc.) only replaced $58.

The logic of free trade works, as long as you kept your job, and aren’t competing with a bunch of people laid off because of free trade. For them, the process of getting rehired by domestic companies that picked up a lot of work because of the deal is taking just a bit longer than expected.

The problem is that industries tend to be concentrated geographically. An entire town might work for one company in one industry. So when that industry is undercut by new imports, the effects are broad and deep in those areas, leaving little employment opportunity for the newly displaced. Rebuilding those areas can take years, if it ever happens.

Moving to a different part of the country is a solution, but anyone with a working spouse and kids knows that such a transition is exceptionally difficult.

Contrary to earlier theories that assumed workers could find new jobs quickly, now it looks like it can take over a decade. The authors estimate that we currently employ 2.4 million fewer people because of Chinese competition.

This doesn’t mean that we should not have free trade, or that we shouldn’t have specialization of labor. These arrangements allow for amazing leaps in technology and standards of living.

But we should keep in mind that just because a TV costs less doesn’t mean everyone wins. Before you can buy a cheap TV, you need to have income. That’s tough without a job.

Follow me on Twitter ;@RJHSDent

By Rodney Johnson, Senior Editor of Economy & Markets

Copyright © 2016 Rodney Johnson - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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