Thursday, March 10, 2016

HAWB 1800s - It was NOT free trade - How America Was Built

During the past two weeks there have been a number of internet postings attempting to understand and explain the popularity of Donald Trump. The most insightful have been by scholars and writers who are willing to look beyond the issue of racism to see the underlying decay of the USA economy. On the Guardian's website March 7, 2015, Thomas Frank, author of What's the Matter with Kansas? How Conservatives Won the Heart of America (2004), The Wrecking Crew: How Conservatives Rule (2008), Pity the Billionaire: The Hard-Times Swindle and the Unlikely Comeback of the Right (2011), and most recently, Listen, Liberal: How the Party of the People Learned to Love Inequality (2016), pointed out that Trump actually does not talk that much about racism. Not compared to what he talks about the most: trade.
It seems to obsess him: the destructive free-trade deals our leaders have made, the many companies that have moved their production facilities to other lands, the phone calls he will make to those companies’ CEOs in order to threaten them with steep tariffs unless they move back to the US.
The fact that working Americans in flyover country are supporting Trump as a way of rejecting economic neo-liberalism and free trade, is even beginning to sink in among conservatives and Republican elites. First Things editor R.R. Reno wrote on March 4, that Trump's appeal has forced Reno to question
very powerful conservative dogma: Our economic problems will be solved by an ever-greater market freedom. This means lower taxes for the rich, those pushing the economy forward. It also means continuing the liberalization of global markets with free trade agreements, as well as de-regulation and the end of government supports for businesses (for example, the Import-Export Bank, subsidies for green power, and other market-distorting initiatives.) In rejecting this dogma, Trump is unique among Republican primary candidates.  
....globalization and ever-freer markets [are] something I’ve long thought is our best option as a nation. I half-recognized the real costs to ordinary people, but I affirmed the homeopathic dogma that still more economic freedom is the best remedy.... In each instance Trump’s successes at the polls have forced me to acknowledge a degree of blindness.
Here, the obvious observation: Those who forget history are doomed to repeat it. Or, history may not repeat, but it rhymes. Whatever. My purpose here is to explain, once again, that "free trade" has never helped a country develop economically. Every country that ever successfully industrialized has used protectionism - i.e., protected its domestic producers and workers from foreign predation.

Once a country has become industrialized, and firmly established its competitive advantage in producing the world's most value-added goods, then it has embraced and promoted free trade.

As Chalmers Johnson writes in his excellent book review of South Korean economist Ha-Joon Chang's 2007 book Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism:
Alexander Hamilton, the first American secretary of the treasury is the man who coined the term "infant industry." Although he did not live to see it, by 1820 Hamilton’s 40 percent tariff on manufactured imports into the United States was an established fact. Hamilton provided the blueprint for U.S. economic policy until the end of the Second World War. In the 19th and early 20th century U.S. tariffs of 40 to 50 percent were then the highest of any country in the world. Throughout this same period, it was also the world’s fastest growing economy. Much like contemporary China, whose average tariff was over 30 percent right up to the 1990s, neither American nor Chinese protectionism inhibited foreign direct investment but rather seemed to stimulate it.
I have already posted about Alexander Hamilton's rejection of Adam Smith's doctrine of free trade.

In the early 1990s, I used data from the Bicentennial Statistical Abstract - Colonial and Historical Statistics, to plot out steel production, railroad mileage built, and coal production, against the various tariff regimes in the 1800s to 1920s. The results were very stark: low tariffs are strongly correlated with downturns in real production, and high tariffs are strongly correlated with increases in real production.

Free Trade Coal v Tariff Free Trade Iron v Tariff

The leading American economist of the mid-1800s, Henry Carey, explained that the ability to import is based on the ability to pay. The ability to pay, in turn, is based on the earning power of the nation’s workforce. If the workforce has to compete against cheaper labor in other countries, then its earning power will be diminished. Carey even anticipated the situation we find ourselves in today, noting that as earning power diminished, the U.S. must buy imports on credit, creating a bubble of indebtedness that must sooner or later burst.

From Carey's 1851 book The Harmony of Interests: Agricultural, Manufacturing and Commercial
VI - How Protection Affects Commerce
Men are everywhere flying from British commerce, which everywhere pursues them. Having exhausted the people of the lower lands of India, it follows them as they retreat toward the fastnesses of the Himalaya. Afghanistan is attempted, while Scinde and the Punjab are subjugated. Siamese provinces are added to the empire of free trade, and war and desolation are carried into China, in order that the Chinese may be compelled to pay for the use of ships, instead of making looms. The Irishman flies to Canada; but there the system follows him, and he feels himself insecure until within this Union. The Englishman and the Scotsman try Southern Africa, and thence they fly to the more distant New Holland, Van Dieman's Land, or New Zealand. The farther they fly, the more they must use ships and other perishable machinery, the less steadily can their efforts be applied, the less must be the power of production, and the fewer must be the equivalents to be exchanged, and yet in the growth of ships, caused by such circumstances, we are told to look for evidence of prosperous commerce!
The British system is built upon cheap labour, by which is meant low priced and worthless labor. Its effect is to cause it to become from day to day more low priced and worthless, and thus to destroy production upon which commerce must be based. The object of protection is to produce dear labour, that is, high-priced and valuable labour, and its effect is to cause it to increase in value from day to day, and to increase the equivalents to be exchanged, to the great increase of commerce. (pp. 71-72)

Free Trade Cartoon Stand Pat
Free Trade Cartoon English come to US
Free Trade Cartoon English come to US caption
From Judge magazine, July 21, 1888: Why? American workman (to John Bull) - Mr. Bull, if Free Trade is such a blessing, why are your agricultural interests in such a wretched condition? Why do your manufacturers cry out for "Fair Trade" and why does your skilled English workman come to this country instead of the American workman going to England?
The United States was economically developed by protectionism in conjunction with two other policies: a national banking system, and government sponsorship and funding of internal improvements – infrastructure. These three policies together were know as The American System, and amounted to a national industrial policy. As Michael Hudson has pointed out, the American System, often also called the American School of political economy, is one of the three major economic philosophies developed in the nineteenth century. The major competitor to the American School was the British school of Adam Smith, Thomas Malthus, and David Ricardo, which developed the theory of free trade as a justification for the British empire's control of the slave and opium trades.
The third philosophy was Marxism.

In the late 1980s, James Fellows of The Atlantic Monthly was converted from a free trader to a proponent of a national industrial policy, including protectionism, when he visited Japan and other countries in Asia, and learned what was really behind their fantastic economic growth and success: the American School of political economy. Fallows tried to reintroduce Americans to forgotten economists like Carey, and Carey's collaborator Friedrich List, in a controversial December 1993 article, How the World Works.
Friedrich List and his best-known American counterpart, Alexander Hamilton, argued that... Societies did not automatically move from farming to small crafts to major industries just because millions of small merchants were making decisions for themselves. If every person put his money where the return was greatest, the money might not automatically go where it would do the nation the most good. For it to do so required a plan, a push, an exercise of central power. 
But this was 13 years after Ronald Reagan had brought to power a group of conservatives, who, on economic policy, were as ideologically rigid as any member of the Central Committee of the Soviet Union. Fallows' article on how Japan and Korea and other "Asian Tigers" had built themselves industrially by strict protectionism and robust government support of economic producers, was simply steamrolled by the free trade and free market ideologues of the "Reagan Revolution." The American School quickly sunk back out of sight.

In April 2011, Ian Fletcher posted on Huffington Post a summary of his book, Free Trade Doesn't Work: What Should Replace It and Why, detailing the faulty assumptions behind the Theory of Comparative Advantage, the theoretical basis of free trade:

Dubious Assumption #1: Trade is sustainable.
Dubious Assumption #2: There are no externalities.
Dubious Assumption #3: Productive resources move easily between industries. 
Dubious Assumption #4: Trade does not raise income inequality.  
Dubious Assumption #5: Capital is not internationally mobile.
Dubious Assumption #6: Short-term efficiency causes long-term growth. 
Dubious Assumption #7: Trade does not induce adverse productivity growth abroad.   

Economists who have attempted to honestly evaluate the effects of free trade agreements such as NAFTA have usually felt compelled to admit that the effects are not as beneficial as they first believed. Robert Scott of the Environmental Policy Institute concludes that the 17-year-old North American Free Trade Agreement, which was supposed to produce trade surpluses and hundreds of thousands of jobs in the United States, actually created "trade deficits with Mexico totaling $97.2 billion [and] displaced 682,900 U.S. jobs."

The historical, statistical fact is that many countries had higher rates of GDP growth and income growth, and significantly less income inequality BEFORE the current world regime of trade agreements came into effect. A study by the Center for Economic and Policy Research in February 2014 noted:
From 1960-1980, Mexican real GDP per person almost doubled, growing by 98.7 percent. By comparison, in the past 20 years it has grown by just 18.6 percent.  Mexico’s per capita GDP growth of just 18.6 percent over the past 20 years is about half of the rate of growth achieved by the rest of Latin America. If NAFTA had been successful in restoring Mexico’s pre-1980 growth rate – when developmentalist economic policies were the norm – Mexico today would be a relatively high income country, with income per person significantly higher than that of Portugal or Greece.  It is unlikely that immigration reform would be a major political issue in the United States, since relatively few Mexicans would seek to cross the border.
After NAFTA, there was also a decline in U.S. exports to Mexico of crucial capital goods such as rail locomotives, machine tools, farm tractors, construction equipment and electricity generating equipment. Proponents of free trade have argued that these types of declines were caused not by NAFTA, but by the peso crisis which occurred soon after NAFTA took effect. But if NAFTA resulted in economic growth, you would expect these declines to eventually be reversed, with the statistics showing improvement ten or fifteen years later.

They do not.

According to Rolling Stock: Locomotives and Rail Cars, Industry Trade and Summary, Publication ITS-08, by the United States International Trade Commission, March 2011, from 2000 to 2009, the locomotive fleet in Mexico has shrunk 19.8 percent, from 1,446 to 1,160. (Table C.124, page 108)
In Canada, the number of freight locomotives fell from 2,979 to 2,671, a fall OF 10.3 percent (Table C.9, page 103). Mexico's active rail car fleet fell by 19.8 percent, from 34,764 in 2000, to 27,873 in 2009. (Table C.16, p110).

What happened in Canada is even worse: a 26.5 percent collapse in rail freight cars from 105,096 in 1999 to 77, 278 in 2008. (Table C10, page 104).

This does not appear to me to be a national economy improving. These are national economies in collapse - exactly what the proponents of protectionism argued would happen through most of the 1800s, and what opponents of NAFTA argued would happen. NAFTA is is not helping the Mexican and Canadian economies improve

Manuel Perez-Rocha, an associate fellow at the Institute for Policy Studies in Washington, D.C., and a Mexican national, said in a review of NAFTA in January 2014,
During NAFTA, Mexico has had the slowest rate of economic growth than [with] any other previous economic strategy since the 1930s. From 1994 to 2013, Mexico’s gross domestic product per capita has grown at a paltry rate of 0.89 percent per year.” Additionally, “During NAFTA, Mexico’s economy grew much slower than almost every Latin American country. So to say that NAFTA has benefited the Mexican economy is also a myth. It has boosted trade and investment, but this has not translated into meaningful growth that generates jobs
In September 2013, three economists, Michael Elsby, Bary Hobijn and Ayşegül Şahin, released the results of their analysis at the Brookings Institution:
The economists——looked at a broad measure of employee compensation capturing all of labor’s share of GDP, and tested it against several different models to figure out what exactly led to this kind of decline. Unsurprisingly, as the chart above shows, they saw a fall in income paid to workers in manufacturing, trade, transportation and utilities starting in 1987, reflecting fewer workers and lower wages.

They ran the regressions, and they found the biggest single thing responsible for falling wages across the entire labor force was import competition. This, they found, explains 3.3 percentage points of the 3.9-percentage-point decline in wages as a share of GDP (that graph at the top) over the past 25 years.
In April 2015, the Royal Economic Society summarized the work of two economists, Hufbauer and Schott, who had written a 1992 study on the expected effects of NAFTA. One source Hufbauer and Schott relied on was a seven-volume report for the World Bank. But what the RES was interested in, was that Hufbauer and Schott had reevaluated the effects of NAFTA in 2005.

Investment largely shifted from portfolio investment to FDI [foreign direct investment], as predicted. However, as Hufbauer and Schott say, ‘Contrary to the expectation that foreign investment would be concentrated in the lowest-skilled activities, the principal impact of FDI in manufacturing was to raise the demand for semi-skilled workers and the wage premium paid to them’. In fact, FDI mostly flowed into existing assets, not into increasing production.10

Other issues feature in the 2005 report that were not prominent in the earlier one. There was a sharp contraction in the number of small and medium sized enterprises, consistent with increased exposure to competitive pressure. There were falls in poverty and inequality - likely to have resulted mainly from the increase in employment following the peso devaluation, and from the Progresa programme of conditional cash payments.11 Another unexpected development was related to dispute settlement: ‘In practice, however, the rules … have fostered litigation by business firms against a broader range of government activity than originally envisaged’. Thus, concentration in enterprise ownership, changes in poverty/inequality, and the extent of dispute settlement, as well as the devaluation, were not even included in the list of predicted effects. And as we have seen, that list of predictions did not turn out to correspond with what actually happened post-NAFTA.
In late 2013, economists David H. Autor, David Dorn and Gordon H. Hanson published a study in The American Economic Review, The China Syndrome: Local Labor Market Effects of Import Competition in the U.S. They concluded that from 1990 to 2007, the share of all manufacturing imports coming from low-income countries increased from 9 percent to about 28 percent, and that this increase in cheap imports accounts for about one-quarter of the aggregate decline in United States manufacturing.
Our analysis finds that exposure to Chinese import competition affects local labor markets not just through manufacturing employment, which unsurprisingly is adversely affected, but also along numerous other margins. Import shocks trigger a decline in wages that is primarily observed outside of the manufacturing sector. Reductions in both employment and wage levels lead to a steep drop in the
average earnings of households. These changes contribute to rising transfer payments through multiple federal and state programs, revealing an important margin of adjustment to trade that the literature has largely overlook.

If free trade is so disastrous in its actual effects, the question that must be asked is: Why do political and economic elites continue to cling to free trade? In Free Trade Is Elites Betraying Their Own Populations, Ian Welsh explains.
The renunciation of tariffs and trade controls is a form of betrayal by in-country elites who have capital to deploy outside the country against everyone else in the country. If a foreign country has lower wages, worse environmental standards, horribly unsafe or coerced labor conditions, this is a comparative advantage.... Internally, free trade is used to create betrayals. Trade deals do not allow environmental protections, do not allow high wages, and do not allow fair treatment of workers. Otherwise, you aren’t competitive and the usual remedies, like tariffs and subsidies, are not allowed by those same trade deals. This allows oligarchs in every country involved in the deal to put downward pressure on wages, regulations, benefits, and even standards of humane treatment, in the name of “competitiveness.”
....Note, again, that this is in oligarchs’ best interest EVEN if their country loses. Greek oligarchs, post-crash, are doing just fine. African potentates walk away with multi-million dollar bank accounts even as their own citizens starve to death. Business owners want to push down wages and costs, no matter where they are. This devastates countries and even the citizenry of many of the winning countries (like the US), but it benefits the few a great deal in relative terms.
In his Guardian post, Frank observed:
Trade is an issue that polarizes Americans by socio-economic status. To the professional class, which encompasses the vast majority of our media figures, economists, Washington officials and Democratic powerbrokers, what they call “free trade” is something so obviously good and noble it doesn’t require explanation or inquiry or even thought. Republican and Democratic leaders alike agree on this, and no amount of facts can move them from their Econ 101 dream. 

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