Why Your Children are Living in Your Basement; and its Not Free Trade!

If you live in the United States, there are several potential reasons why your children might be living in your basement, or simply can’t find a “good” job.  None of those reasons, however, are related to “free trade”.  In fact, free trade does not exist today.  The confusion is understandable as one supposed free trade agreement after another is codified by our government.  The truth is that free trade requires no agreement.  The same narrative has been around for so long, it is as if it has always existed.  And, it has.  As the story goes; “unfair” global competition or “free trade” is causing massive unemployment and economic problems at home.  Governments, labor, business and industries, have all complained about “unfair” competition for centuries.

To widen the market and to narrow the competition, is always the interest of the dealers.  The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it.

The Wealth Of Nations, Book I, Chapter XI, Conclusion of the Chapter, p.267, para. 10.

Though we could apply our line of reasoning to any country at any time in history, for now, let’s focus on approximately the last 50 years in the United States.  The claims have been that the Japanese are undercutting US car manufacturers, China is “dumping” steel and foreign countries, in general, are “exploiting” labor.  The purported intent of policies designed to mitigate the damage of competition has always been to save jobs.  But, don’t be fooled.  This is code for expand government and subsidize unions and the shareholders of inefficient domestic businesses at the expense of every US citizen.  And, what has been the result?  By the US following policies of government expansion, trade protection and papering over the problem with debt, it has dug its own grave by destroying opportunities for younger generations of Americans and supported foreign labor and their trade policies in the process.  The reality is, a proper US government response would have been to accept foreign charity, in the form of cheap goods, lower the cost of living for every American citizen, free-up capital and re-tool the economy for real growth.

Free Trade

How does free trade work and how does it benefit everyone, not just a privileged few?  Let’s take an extreme example where China could produce every single product 50% cheaper than what could be produced in the United States.  It would pay every citizen of the United States to go online and buy every product from them, and absent government restrictions, they would.  China would be flooded with US dollars.  Initially, Chinese citizens would not be inclined to use those dollars to purchase US goods because every product would be less expensive in their home country.  Instead, they would need to exchange their US dollars for home currency, yuan, and purchase domestically produced goods.  Given an overwhelming demand for yuan and selling pressure on the US dollar, the value of the US dollar and yuan would reach equilibrium in short order.  When adjusted for currency valuation, equivalent products in the United States and China would cost the same to produce.  Of, course, this is an extreme example, but an accurate picture of how the process is supposed to work.

Using our example, while this situation would, temporarily, be very painful for those that lost their jobs, other opportunities would present themselves while housing, food, clothing, etc, would be less expensive in real terms.  Government, at all levels, would have to reduce its share of the production and resources it obtains through taxation, as well as reduce regulations and the cost of compliance.  Land, plants, factories and equipment, would all go down in price.  In general, the cost of capital and labor, in comparison to the foreign country, would decline dramatically.  And, what would happen in China?  In real terms, prices would go up.  Demand would be so great that the cost of labor, and all other factors of production, would increase substantially, reflected in an appreciated yuan.  Housing, food, clothing, and other costs of living would go up as well.  In our rather dramatic example, and as referred to above, the trade imbalance would be closed rather quickly.  US labor and industry would emerge much more competitive and could go about producing and selling again.  Not only would US industry be more competitive domestically, but now the entire world would be a potential market.  But nothing, even remotely close to that, was permitted to play out.

Government Expansion

Is you were to listen to government experts tell it, they are required to step in and save the economy when free markets fail.  Nothing could be further from the truth.  Prior to the 1970’s, the United States had, since the Hoover administration, already vastly expanded the role of the federal government in the economy.  Along with the Federal Reserve, The Tariff Act of 1930 (codified at 19 U.S.C. ch. 4) otherwise known as the Smoot–Hawley Tariff and signed into law on June 17, 1930, it was Hoover’s role in meddling in the economy that prevented recovery and formed the beginning of the Great Depression.  Even the most ardent Franklin Roosevelt, New Deal, supporters regularly claim that it was World War II, not the New Deal, that pulled the country from its economic malaise.  The New Deal extended the Great Depression.  The claim of war, incidentally, being a benefit to the economies of the combatants is equally as fallacious, but not our topic at the moment.  This much is true, expanding the size and/or control of government over an economy at best will simply favor one group or industry at the expense of everyone else.  At its worst, government expansion acts to misalign incentives, squanders scarce resources and destroys competitiveness.

As the mid-twentieth century decades wore on new agencies and government jobs replaced private-sector employment.  Eventually, certain “social” policies lead to entitlements that replaced employment all together.  A substantial increase in the size and presence of the US and other western governments actually perpetuated the loss of industry and productive jobs over the last five decades, and certainly never saved any jobs.  I am not contending that every productive job lost could have been saved through free workings of the labor markets, but a government job, or someone sitting at home watching television or playing video games and collecting welfare, are not substitutes for productive private-sector employment.  Would some industries have gone away?  Yes, but other industries would have grown up to replace what was lost.  The US may have been more efficient at producing oil and natural gas, for example; China more efficient at producing clothing.

It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy.  If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.  Adam Smith, Wealth of Nations, 1776

Trade Protection

Obstructing free trade through protectionism is simple price manipulation and price discovery is, perhaps, the most important fundamental in economics.  Yes, obstructing free trade, not free trade itself, leads to loss of opportunities.  When you alter prices through tariffs or by subsidizing exports, you end up losing in the end.  Adam Smith’s invisible hand will always work to correct the situation and mankind can only fight against it for so long.  With regard to the critical early 1970’s time period, when the handwriting was on the wall, US officials maintained trade barriers, tariffs and quotas.  A series of managed trade agreements, not free trade agreements, have followed to this day.  None of the actions taken, however, have been sufficient to save industries and jobs.  Emperically, the evidence is crystal clear, managed protectionist trade deals in fact destroy opportunities and raise the cost and lower the standard of living for most Americans.

Some would argue that trade barriers have been and are, today, much lower than they have been historically, and for the most part they would be correct.  In relative terms I would place the expansion of governments role, outside of foreign trade policy, in the economy and profligate spending and massive debts, over trade restrictions.  For every industry or job protected, however, and whether that industry is government and the job a bureaucrat, or a private sector industry and job, at least one other job is lost.  But, it is worse than a one-for-one substitution.  If we could replace all private sector productive employment with people sitting at home surfing the internet or performing other non or unproductive tasks, a one for one trade-off might not be so bad.  The key is that any trade restrictions misallocate scarce resources, labor and capital, ultimately making the entire economy less productive and competitive.

Government Debt

In addition to expanding unproductive and counter productive government agencies, programs and initiatives and trade protectionist policies, our government ran up massive fiscal deficits to not only fund over-priced and inefficient industry, but to fund other social, welfare and defense “priorities”.  Over the decades that followed, Asian countries would gorge on US debt, instead of US products and services.  By the US maintaining artificially elevated pricing structures in government, labor and capital, the Chinese, Japanese, and other Asian countries, were almost forced to indulge our borrowed, literally, lifestyles.  To a large degree, the massive US government debt pile reflects nothing more or less than the extension of vendor-financing by Asian, and other, producers on behalf of its US customers.

Some blame our trade ills on the “exorbitant privilege” of having the US dollar as the world reserve currency. ( The Exorbitant Privilege and its Stubborn Costs by Robert J. Samuelson, Washington Post)  This, of course, in reference to Brenton Woods and the purported “indestructible curse” of chronic massive trade deficits and price disadvantages for manufacturing.  Is reserve status of the US dollar, in fact, to blame for a decline in US labor and manufacturing?  I would contend that the US ran constant trade deficits and US manufacturing declined because the country, as a whole, did not wish to make the tough choices that were necessary.  This was under the complete control of US leadership who were responsible for making those tough decisions, not foreign competition.

Conclusion

This problem could have been solved fifty years ago.  Government withdrawal from the economy, sound free trade practices and balanced budgets would have ensured a lower cost of living, rising wealth and greater opportunities for everyone.  Instead, politicians sold out to industry and special interest groups in exchange for votes.  There would have been short-term pain, no doubt, as new Asian participants forced wages and the cost of capital lower.  But, the suffering would not have been exclusive to labor, as is the case now.  Capital owners and management ranks would have been deeply impacted as well.  Wealth built during the industrial revolution and post-war boom would have declined; clearing the way for new industries, or even the return of old industries under new ownership.

Let’s set aside the “lazy” or those that are simply not employable for any reason.  The current generation of millennials is no different from any other generation of Americans; they want to be productive, increase their lot in life, raise families and save for the future.  Unfortunately, for them and the youth in other so-called “developed” countries, many do not have that opportunity.  Why?  “Developed country”, currently stands for, “we racked up a ton of debt on the backs of our children and grandchildren so we would not have to make tough choices”.  I am not claiming that this was done by the citizens intentionally, but it is the impact of decades worth of policy decisions by government, in an attempt to placate special interests.  So, it is most certainly not “unfair” trade  or “free trade” that has led to your children living in your basement.  Instead, the blame lies with massive government expansion, utilization of ill-fated trade protectionist policies and massive fiscal deficits in response to global competition.

And, rather timely: US Calls for 256% Tariff on Imports of Steel From China


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