Commentary

A Personal Overview of U.S. Trade Policy

By William A. Niskanen
This essay is taken from Future Visions for U.S. Trade Policy, Council on Foreign Relations, 1998, pp. 38-45.

Over the past 25 years the international trade share of the American economy has roughly doubled, a process that we now call globalization. Americans should welcome this increase in international trade and investment, not fear it as a problem. I bring two perspectives about the issues raised by this process — one about freedom and rights and the other about economics.

As much as possible, people ought to be free to make the same type of consensual arrangements across a national border as are legal within the jurisdiction of each nation. In general, for example, consumers and producers in a market economy have the right to make most types of transactions without the approval of other people and firms, such as the workers and owners of competing firms, who may have an indirect “stakeholder” interest in these transactions. This is a necessary consequence of the fact that the rights to property include the right to buy and sell property but do not include a mutually incompatible right against otherwise-legal actions that may affect the market value of the property. A plea by workers at Ford Motor Company for consumers not to buy Chrysler cars, for example, would fall on deaf ears. For the most part, people have the same type of right to move their labor and capital within a nation without the approval of other interested parties.

All too often, however, domestic producers try to restrict the right of domestic consumers to buy from foreign producers, and domestic consumers try to restrict the right of domestic producers to sell to foreign consumers. Since producer interests are generally more concentrated than consumer interests and, given the costs of organizing a diffuse group, likely to be more politically influential, most restrictions on international trade are on imports, not exports. For many years, for example, our government has restricted the import of apparel and sugar; more recently, our government pressured other governments to impose “voluntary” restraints on the export of automobiles, steel, and machine tools to the United States, measures that were otherwise illegal under U.S. and international trade law. (The major exception to the dominance of import restraints is when the government itself is the major domestic consumer; the export of many goods and services important to the military, for example, is subject to specific export controls.) This is a simple but nearly sufficient explanation of the distinctive politics of international trade policy, both in the United States and other nations. Most governments restrict trade across their national borders by means and for reasons that we would not, and should not, tolerate on trade within our own national borders. And the politics of international migration and investment policy are base on roughly the same considerations.

Our freedom and our rights, in summary, are increased by reducing the policy restrictions on trade, migration, and investment across national borders. With Adam Smith, however, I acknowledge that “defense is more important than opulence.” For that reason, I support distinctive policies at our national borders based on important national security interests. But the burden of proof should be on these who would restrict our right to make consensual arrangements across national borders on other grounds.

As an economist, my professional perspective also makes little distinction between domestic and international trade. Any consensual transaction, by its nature, is expected to increase the well-being of both parties to the transaction; otherwise, one or both parties would not agree to the transaction. The somewhat less intuitive conclusion by economists is that reducing the barriers to international trade, with only a few exceptions, increases the average income in the affected nations, even if the increased trade indirectly reduces the income of some people. In our stilted jargon, reducing trade barriers is described as a potential Pareto game, in that the increased benefits to the trading parties are larger than the losses to some other parties. One exception to this general conclusion that is now broadly accepted by economists is the rare case when the economies of scale are so strong, such as may be the case for such products as supercomputers and wide-bodied commercial aircraft, that the relevant market can only support one or two producers. In that narrow case, the average income in one nation may be increased by measures to assure the survival of a domestic firm, but only if the benefits to the surviving firm are larger than the costs of winning the competitive contest. Unfortunately, this theory of “strategic trade” has been misused in the attempt to justify all sorts of interventionist trade policy. One of the major developers of this “strategic trade” theory has been sufficiently concerned about some people taking his lectures too seriously that he has recently minimized the substantive relevance of this exception. One other recent finding, with ambiguous effects on the U.S. economy but clear benefits to most nations, is that increased international trade spreads the benefits of research and development conducted in other countries.

Economic and Political Effects

Enough political philosophy and economic theory. Let’s now discuss some of the real-world effects of increased international trade and the implications of both theory and experience for American trade policy.

One effect on our economy should be obvious: the incomes of some workers and some investors will decline as a result of increased foreign competition, even if these same people gain as consumers. The most important conclusion is that low-skilled workers in high-wage countries will have trouble in our increasingly global economy. In the United States, this is most likely to be reflected by lower real wages; in Europe, because their labor markets are less flexible, this effect is manifested by higher unemployment. Economists are still trying to sort out the relative magnitude of the trade effect on the earnings of low skilled workers. At most, 10 to 25 percent of the increase in the variance of U.S. wages by the mid-1980s seems to be attributable to increased international trade, but this will remain a controversial issue for some time.

Sorting out this issues is an inherently difficult task, because a number of other important developments have occurred during the same period in which the trade-affected share of our economy has increased substantially. Most important, we seem to be in the early stages of a third industrial revolution, one based on digital technology; this has increased the relative demand for skilled workers. In the United States, in addition, the average job-related skills and work attitudes of recent high school graduates seems to have declined, and the immigration rate increased sharply. Commentators on the left are prone to attribute the lower real wages of low-skilled workers to the decline in union membership, a lower real minimum wage, or tight monetary policy. And, for whatever reasons, the average measured productivity growth in recent decades has been substantially lower than during the first decades after World War II. Our political system, however, will not wait for economists to sort out this issue. The lower real wage of low skilled workers has already affected the politics of trade and immigration policies, as reflected by the reduction of welfare services available to immigrants and the recent defeat of President Clinton’s request for renewed fast track authority. Average voters and the politicians they elect have noted the parallel trends of increased international trade and increased variance of wages and have drawn their own conclusions.

On the other hand, the concern by many noneconomists that increased trade would reduce total employment has proved to be a false alarm. For the United States, increased trade has been consistent with a rapid increase in total employment, the two longest peacetime recoveries on record, and the lowest combination of unemployment and inflation in three decades. Total civilian employment has increased about 200,000 a month since the approval of the North American Free Trade Agreement (NAFTA). That “giant sucking sound” that Reform Party presidential candidate Ross Perot attributed to NAFTA must have been due to a vacuum in his brain cavity.

The Major Problems of U.S. Trade Policy

Although our broad economic and trade conditions are favorable, there are several serious problems with U.S. trade policy.

First, I am least concerned about the fast track issue. The recent defeat of President Clinton’s request for the renewal of fast track authority is an ominous portent of the reaction of Congress to future trade issues, but the lack of fast track authority, by itself, does not substantially reduce the opportunity to improve U.S. trade policy. Our government can unilaterally reduce its trade barriers without negotiating with other governments. And many bilateral and some sector-specific agreements can be negotiated without fast track authority.

The major trade agreement that is blocked by the lack of fast track authority is the proposed Free Trade Agreement of the Americas (FTAA). Although the FTAA seems like a logical extension of NAFTA, there are strong reasons to oppose this new agreement. Canada and Mexico were our first and third largest trading partners before NAFTA, so there was less reason to worry about trade diversion (from more efficient suppliers outside the region) that is a characteristic of regional trade agreements. And, in fact, NAFTA has contributed to a substantial increase in U.S.-Mexico trade with little apparent trade diversion. By contrast, the United States has surprisingly little current trade with the Latin American countries south of Mexico. For that reason, the FTAA is likely to lead to more trade diversion than increased trade within the hemisphere. And the FTAA, in turn, is more likely to be a stumbling block than a building block to a broader global agreement, because the diverted trade would create new interests within the hemisphere that would be threatened by global free trade.

For the past 12 years, the most distinctive characteristic of U.S. trade policy has been an attempt to open foreign markets by any means short of gunboats. (In fact, we came perilously close to using gunboats in late l997, when the obscure Federal Maritime Commission ordered the Coast Guard to take some Japanese ships in U.S. ports as hostages to resolve a long standing dispute about practices in Japanese ports.) The focus of these U.S. trade actions has been on the alleged effects of foreign regulations, market structure, and business practices on the U.S. market share in other nations, whether or not these conditions were a violation of existing trade agreements. The exercise of this Section 301 authority, primarily against Japan, has made many other governments regard the U.S. government as the major bully of world trade. The most significant change in the use of this authority, beginning in 1985, was a shift of focus from redressing unfair trade practices to fostering market share outcomes that were perceived to be more fair to U.S. exporters. In any event, the rule of law in international trade would be best served by shifting all of these disputes to the World Trade Organization (WTO) for resolution — the route commendably taken by the U.S. trade representative in the dispute between Kodak and Fuji Film, even though the United States lost the case. The decision to rely first and foremost on the WTO in all bilateral trade disputes is a decision that the U.S. government can take as a matter of administrative practice.

For many more years, the most abused section of U.S. trade law has been the rules bearing on “dumping” by foreign firms in the U.S. market. This authority is designed to penalize foreign firms from selling in the American market at a price lower than in their home market or lower than an arbitrary U.S. government estimate of their cost, if such sales are also determined to cause injury to some U.S. industry. In practice, foreign firms have found it difficult to defend themselves against pricing practices that are a regular part of the domestic marketing strategies of many U.S. firms. Sooner or later, consistent with the national treatment principle of international trade law, we should dump the dumping code and judge both foreign and domestic firms selling in the American market by the same existing U.S. law against predatory pricing. This is a change that the executive branch and Congress can make, with no quid pro quo from foreign countries.

Another type of U.S. trade policy that is subject to considerable abuse is the increasing use of trade sanctions for foreign policy objectives. As of March l997, there were 61 U.S. trade sanctions against 35 countries with a total population of over two billion people. This total does not include the many trade sanctions approved by selected state legislatures and city councils. I sympathize with the concern of our foreign policy officials for some instrument between “jaw, jaw and war, war” (Winston Churchill’s phrase). Trade sanctions, however, are seldom effective unless two conditions apply: The sanction is enforced by almost all the trading partners of the target country. And the government of the target country is at least moderately responsive to the interests of the population. The first condition has rarely been possible since the end of the Cold War. And the most frequent targets of sanctions are the governments that are least responsive to the interests of the subject population. Even when sanctions are effective in changing the behavior of the target government, they do so by harming many innocent people in the target country, including, importantly, those who are most likely to be sympathetic to the U.S. position on the issue in dispute. For the most part, trade sanctions are part of symbolic politics, an opportunity for politicians to decry some condition without any realistic prospect that the sanction will relieve that condition. Again, reform of these practices is a matter for the president and Congress.

Finally, the major future threat to international trade is the growing pressure for including some common rules affecting labor, the environment, and antitrust policy in future trade agreements. Such pressure usually arises from firms and unions in industries and countries subject to relatively high-cost regulation, where the harmonization of such rules would have the effect of raising the costs of their foreign competitors. (A broad harmonization of some rules may be necessary to address problems of world-wide impact, such as global warming may turn outd to be; such conditions, however, are rare or not very important.) Many governments, in turn, are increasingly willing to allow firms to compete across national borders but prefer a cozy cartel among themselves to set the peripheral rules affecting such trade. No one has yet offered a good explanation why competition in the market for goods and services is desirable but competition among government fiscal and regulatory policies is not. At stake in this debate is whether globalization of the economy will lead to global rule making or global competition in rule making. My position on this issue, as you may suspect, is that monopoly government is the more serious threat to our freedom.

Conclusion

The increased role of international trade, much like the effects of a major new technology, presents opportunities for many people and problems for some. A confident nation should welcome this change —not passively, but by addressing the conditions that contribute to the selective problems and the major problems of our current policies. The major problem presented by both globalization and new technology is the effect on the earnings of low-skilled workers; this should lead us to address the performance of our public school system, the school to work transition, and the opportunities for vocational training on the job — rather than by closing off the opportunities presented by these major changes. Since more of our economy will be affected by international trade, it is especially important to address the major problems of our current trade policy. We should also address those fiscal and regulatory policies that increase the relative cost of American firms in the global market — rather than by pressuring other governments to adopt similar policies.

The global economy presents new opportunities for Americans as consumers, producers, and citizens. Consumers will benefit by new goods and services and more competition in domestic markets. More producers will benefit by the increased opportunities to sell in the global market. And the increased indirect competition among governments will benefit most of us as citizens. In general, the increased opportunity to trade across national borders will increase both our freedom and the economy. Again, in summary, Americans should welcome the globalization of our economy as an opportunity — not fear it as a problem.

William A. Niskanen is chairman emeritus and a distinguished senior economist at the Cato Institute. He served as chairman of the Council of Economic Advisers in the Reagan administration.