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America trades down

The elites who are savaging Bush for imposing quotas on foreign steel are wrong. Blue-collar workers in Pittsburgh and elsewhere know that 'free trade' is not fair trade

Sunday, June 09, 2002

By Raymond L. Richman

Democrats, a number of Republicans and the conservative Heritage Foundation have criticized George W. Bush for imposing a protective tariff on steel. Paul Krugman, an economics professor and syndicated columnist, goes further, writing in an article published in the May 28 Post-Gazette that "it demonstrates an unprecedented contempt for international rules" and "weighed three electoral votes in West Virginia against the world trading system built up over 60 years."

 
 

Raymond L. Richman is professor emeritus of public and international affairs at the University of Pittsburgh. His e-mail is rayrwtcr@aol.com.

   
 

Krugman is shocked, shocked, that the president had political motives. Without doubt, Bush was playing politics and was violating the World Trade Organization's rules on international trade. It is politically correct to be for free trade and American economists almost unanimously favor free trade.

But there are reasonable doubts about the value of free trade when a country experiences chronic trade deficits for three decades as the United States has done, with the deficit reaching the staggering sum of $449 billion in 2001, with exports valued at $731 billion and imports, $1.18 trillion.

The rules of the General Agreement on Tariffs and Trade (succeeded by the World Trade Organization) were developed after World War II when America was the only economic power in the world and was willing to make sacrifices to aid the rest of the world.

We could afford then to be very generous, allowing most nations to maintain very high tariffs and other barriers to trade at the same time that we reduced ours to the lowest of any major industrial country. We agreed to rules that are biased against United States manufacturers in general and the steel industry in particular. Those rules ought to be changed, and it is time that the rest of the world reduced tariffs to our levels.

The deficits transformed the United States from the world's greatest creditor nation to the world's largest debtor in less than 20 years. In the process, as blue-collar workers in this region are well aware, it destroyed millions of well-paying jobs in the manufacturing sector, driving those workers into lower-paid, less productive jobs.

The benefits from trade, the lower prices for consumers and increased incomes and employment in the export industries, fell far short of the costs borne by the manufacturing sector and its employees because exports fell far short of imports, currently only 62 percent of imports. Only when trade is in balance can we be sure that benefits exceed the costs.

President Bush, though he may not have known it, had good sound economic reasons for imposing a tariff on steel. Every economic textbook extols the virtues of free trade, seldom making clear that the author is assuming trade is in balance. There is a big difference between the virtues of free trade when trade is in balance and its virtues when it is unbalanced.

The most common illustration of the benefits of trade in Econ 101 is that of two countries, each of which is capable of producing wheat and cloth. It is shown that each, by specializing in the one in which it has a comparative advantage, will be able to enjoy a higher level of consumption of both. One notes in these examples that both countries end up exchanging goods of equal value, i.e., imports equal exports.

Nobody raises the question, "Do both benefit if one imports twice what it exports?" When it is asked, the facile answer is "Why would a country want to continue giving away its product?" It doesn't give it away; it accumulates reserves, real assets, financial assets, and exports its unemployment while the importing country is mortgaging its future. The exporting country becomes a creditor, the importing country a debtor.

Trade deficits are not always bad. They can sometimes make an important contribution to economic growth. This is the case where the deficit is the result of direct investment that finances the importation of capital goods that increase productivity -- new machinery and equipment, new and improved factories, improved infrastructure in transportation, power, water, sewerage, education and so on, what the economist calls direct investment. A highly developed country like the United States, however, should be exporting capital to the less developed countries instead of being on the receiving end.

The trade deficits of the past 30 years did not hurt teachers and government employees, journalists, workers in the service industries and other workers who face no foreign competition. Nor did it hurt the yuppies and others who found high-paying jobs in the booming securities markets and the high technology sectors. But it did hurt the workers in steel and a host of other manufacturing industries, all but the export industries.

One ought to have expected that the blue-collar labor unions would have raised hell. But today's labor movement is dominated by the white-collar unions, which have no stake in foreign trade. They can take the politically correct road of free trade and globalization. Unlike blue-collar workers, they have nothing to lose.

Trade deficits are sometimes blamed on wage differences. Forty years ago, wages in Japan were a fraction of U.S. wages and American unions complained about the "unfair" advantage that the Japanese had. We don't hear much about Japanese labor anymore since Japanese wages are as high or higher than in the United States. Still Japan continues to enjoy a huge trade surplus with the United States, amounting to $70.6 billion in 2001 (and it has announced that it would retaliate against the new tariff on steel!).

How did this happen? The Japanese personal savings rate is in the high double digits; our rate hovers close to zero. They are exporters of capital, we are importers. Indeed, we have become extremely dependent on foreign capital. The key to the deficit is the flow of capital to the United States.

Capital moves to where it can get the best return. One would expect capital to flow to those countries in which qualified labor is cheaper. And it would, if other things were equal.

Why does it flow to the United States, where wages are as high as anywhere in the world? Because there are few countries in the world that offer decent returns to capital, enjoy stable government, encourage entrepreneurship, and respect property rights. There are almost none in Latin America, Africa and Asia. There's only the European Union, a relatively young association that has not so far had to face any real problems and it has predominantly socialist parties in power that are hostile to private enterprise. Its new unified currency, the euro, has fluctuated widely.

So far, capital prefers the United States as a haven, but this may change. It may already be changing. The capital flows to the United States contributed to the growth of the U.S. capital stock by supplementing our low rate of personal savings. But a lot of it merely contributed to a booming stock market and a strong dollar that discouraged exports and encouraged imports.

That poses a real threat to our economic prosperity because the direction of flow has to change. There is some evidence that the dollar has begun to weaken already, the rise in the value of the euro and the rise in the price of gold.

Protective tariffs are not the answer to the problem of the chronic trade deficits even though in some cases -- steel for example -- a great deal of the foreign competition is unfair. Under WTO rules, a country is guilty of dumping when the price of an export is below its costs of production, what economists call its variable costs.

But private industry has to recover its fixed costs, the costs of plant and equipment. Socialist industries do not. A case in point is the great steel mill built at Ouro Branco by the Brazilian government at a cost estimated to have been between $6 billion and $8 billion, equivalent in 2002 dollars to $15 billion to $20 billion, which never had to be recovered. Give the most inefficient steel producer in the United States a free steel plant and he will be able to undersell anyone in the world.

The other bias in the rules is the permission granted to all members of the World Trade Organization to rebate value-added taxes to exporters. These rebates sometimes amount to a sixth or more of the domestic price. Japanese and European goods sell at lower prices in the United States than they do at home. And when other countries import our goods, they impose excise and value-added taxes -- but they aren't considered tariffs. The United States does not impose a value-added tax and the rules forbid rebating income taxes.

So what can be done? We could impose a tax on imports equal to the taxes other nations rebate on their exports. Let's not call it a tariff, just an "equalization excise tax."

We could abolish the U.S. corporate income tax and replace it with a value-added tax. The proposed so-called flat tax was in effect a value-added tax. While changes in the rules of international trade would ameliorate the problems faced by U.S. manufacturers, it is not a solution to the problem of trade deficits which is a product of international capital flows.

What we really need are policies that discourage the inflow of capital to purchase existing assets like stocks and bonds while encouraging direct investment in new productive facilities. The latter stays here; the former is ephemeral and subject to sudden withdrawal.

Any sudden change in the direction and magnitude of capital flows can have serious consequences to our economy. The Asian crises of the late 1990s ought to have alerted us to the dangers of sudden changes in the magnitude and direction of capital flows. We have to change its direction without causing a flight of capital and bring trade into balance to avoid further damage to our manufacturing industries.

Like new rules for international trade, we need to have new rules regarding foreign investment that make its flow stable and balanced.

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