Why Free Trade Is Good for Consumers
Ellig, Jerry, Consumers' Research Magazine
Americans enjoy freedoms that are envied and emulated around the globe. But when Americans try to sell the products of their labor to consumers in other countries, or purchase products made outside the United States, government trade policy limits our freedom.
Trade barriers such as quotas and tariffs, as well as environment and labor provisions attached to trade agreements, make Americans poorer by limiting their ability to trade. Free trade, on the other hand, generates significant savings for consumers and new opportunities for workers.
Popular protectionist arguments view trade, or the trade deficit, as a threat to economic security. In reality, there is no necessary relationship between unemployment and the volume of trade or trade deficits. Imports, exports, and employment all rise as the economy grows.
Why Trade Matters. During the past two decades, information technology and deregulation of communications and transportation have made goods, people, work, and investment capital more mobile than ever before. As a result, more Americans than ever have a stake in the global economy.
An autoworker in Tennessee, for example, assembles parts from the United States, Canada, and/or Mexico into a car destined for Florida, using production management methods borrowed from Japanese automakers that learned them from an American. Driving home, he stops for gas at a station owned by Royal Dutch Shell. Like many Americans, a big chunk of his retirement savings is invested in "foreign" companies like Siemens, Unilever, and DaimlerChrysler--and in "American" companies like Coca-Cola and Procter & Gamble, which actually earn a huge portion of their revenues overseas. The U.S.-based insurance company that protects his home and family sends its paperwork to Ireland for processing.
Because of such globalization, the American economy's dependence on trade has doubled since 1980. Total U.S. trade (exports plus imports) rose from 14% of GDP in 1980 to 29% in 1997. Most of this growth occurred just since 1990, when trade equaled 19% of GDP.
Ongoing developments promise to expand international trade still further. In November 1999, members of the World Trade Organization began meeting to negotiate new agreements that would further reduce tariffs, eliminate import quotas, and open world markets to trade in both goods and services. (See "World Trade, Consumers, and Seattle," at page 34.) Many developing nations formerly hostile to Western influence are now eager to drop their substantial trade barriers in exchange for access to industrialized nations' markets.
Direct Consumer Benefits
* Lower prices. The most obvious way free trade benefits American consumers is by making imports less expensive. The United States practices selective protectionism; tariffs, quotas, and outright prohibitions generate significant price increases for textiles, clothing, peanuts, leather goods, tile, and shipping. A 1999 study by the U.S. International Trade Commission estimated that removal of U.S. import barriers in 1996 would have reduced the prices of these products and services by 6% to 37%, depending on the item.
Free trade can bring big benefits even if it produces only modest price reductions. For example, U.S. tariffs raise the price of ball bearings by only 2.2%, but American firms buy so many ball bearings that they pay at least $214 million more than they would under free trade. Thanks to protectionism, American consumers and businesses paid an extra $6.1 billion for products and services, including textiles and apparel, agriculture, maritime transportation, footwear, and other high-tariff items.
* Regressive protectionism. Some of the biggest price increases occur on necessities like food and clothing. Producers of sugar, peanuts, milk, butter, and cheese receive significant protection from foreign competition. Even more important, however, is the effect of trade barriers on textiles and apparel. William Cline, a senior fellow at the Institute for International Economics, estimated that the poorest 20% of Americans lose 3.8% of their income each year due to textile and apparel protectionism. Because middle- and upper-income Americans spend a smaller fraction of their income on clothing, protectionism is less of a burden for them; import barriers steal "only" 1% of wealthier Americans' income.
* Trade improves quality. Consumers care about more than price; quality matters too. By exposing domestic companies to diverse overseas competitors, free trade creates pressure to improve quality--often in radical ways.
Nothing proves this point more clearly than the auto industry. In the 1950s, when "Made in Japan" was synonymous with "junk," few Americans wanted Japanese cars even though they were inexpensive. However, several Japanese automakers developed quality management techniques that eventually allowed them to produce much higher quality vehicles than Detroit at a comparable cost. The Japanese based their techniques in part on the ideas of W. Edwards Deming, an American who was largely ignored by the U.S. auto industry until the 1980s. Between 1970 and 1981, Japanese automakers' share of the U.S. market rose from 15% to 25%. The figure below shows a big reason for this increase: after 1974, the Japanese companies produced higher quality cars.
The surge of Japanese imports had two effects on the quality of cars available to American consumers. First, Americans had the chance to purchase higher quality Japanese cars. Second, Japanese competition placed pressure on the Big Three U.S. automakers to improve their own quality.
* Indirect Consumer Benefit: Economic Growth. In addition to lowering prices and improving quality, trade benefits consumers in another, less obvious way: by expanding the economy's ability to produce. Trade allows people in different nations to specialize in those activities where they are most productive. It also allows investment to flow to its most productive uses. Obviously, if people are more productive, they can produce more--and if they can produce more, they can earn more and consume more.
The May 1999 U.S. ITC study estimated that consumer income would have been $12.4 billion higher in 1996 if major U.S. import restraints were removed. By far the largest amount, $10.4 billion, came from removal of textile and apparel protectionism, "the Mount Everest of US trade protection." Removal of all import restraints would have raised consumer income by $14.9 billion.
The figure at right illustrates the more general relationship between trade and economic growth. For decades, U.S. GDP, personal consumption, and total trade have risen in tandem. Imports as well as exports have risen as the economy has expanded. Of course, the graph does not claim to show that trade is responsible for all of U.S. economic growth. But it is clear that trade--and even imports--increase along with GDP.
* Ringing up the total. The total benefit to consumers from free trade is the sum of price reductions plus increases in consumer income. This figure equals $21 billion as of 1996, based on data in the ITC study. That's equivalent to $325 for a typical family of four. It's also equal to $155,000 per job "saved" in the protected industries--clearly more than most of these jobs pay. As economists have argued for two centuries, protectionism's cost to consumers clearly outweighs the benefits it bestows on workers in politically powerful industries.
Free Trade = Better Jobs
* Jobs lost and jobs saved. Protectionists often argue that large numbers of jobs are "lost" to imports, while free traders note that trade creates jobs in export industries. But counting up these categories of jobs misses the main point. The most important effect of free trade is that it replaces jobs that are less productive with jobs that are more productive.
Because trade moves workers to jobs where they are more productive, it tends to replace low-wage jobs with high-wage jobs. Of course, trade creates some additional jobs in relatively low-wage fields like retailing and agriculture. However, trade also expands fields like wholesaling, mining, transportation, communications, and other areas that pay quite well. Perhaps even more surprising, the ITC study found that removal of major U.S. trade barriers in 1996 would have created more jobs in manufacturing than in any other part of the economy. For example, employment in durable manufacturing would have grown by 65,840, and jobs in nondurable manufacturing would have grown by another 12,000.
How many of these jobs are actually "good" jobs? The following table demonstrates that virtually all of the jobs that would be created by free trade are in industries that pay better than the national average. Protectionism destroys high-wage jobs.
Hourly earnings in sectors where trade creates jobs
Agriculture $7.47 (1998 avg.) Construction $16.80 (Jan. 1999) Manufacturing $13.64 (Jan. 1999) Finance, Insurance, Real Estate $14.46 (Jan. 1999) Mining $17.07 (Jan. 1999) Services $13.17 (Jan. 1999) Transportation, Utilities $15.49 (Jan. 1999) Wholesale Trade $14.36 (Jan. 1999) Retail Trade $8.93 (Jan. 1999) National Average, private sector $13.04 (Jan. 1999)
SOURCE: Hourly wage of hired farm workers in 1998 is from the U.S. Department of Agriculture. Hourly earnings of all other production workers in January 1999 are from the Bureau of Labor Statistics.
* What about low-wage workers? Another job-related fear is that trade increases income inequality by reducing the wages of unskilled workers who produce products that compete with imports. The concern here is not that trade destroys high-paying jobs, but that it reduces pay in low-wage jobs.
It is true that U.S. income inequality has risen since the 1970s. The fact that imports have risen during this period leads many to conclude that trade is responsible for rising inequality.
Dozens of economic studies examine this hypothesis. Most find that trade is responsible for only a small amount of the increase in inequality-most likely between 2% and 7% of the change, and no more than 22%. The most important factor by far is technological change, which has raised the rewards to education. Technology is four or five times as important as trade. Other influences even less important than trade include the decline of unionization, immigration, and the falling real minimum wage.
Even most of the economists who think trade harms low-wage workers reject protectionism as a solution, usually favoring improved education and training instead. There's a good reason. Although trade protection may raise the pay of some low-wage workers, it also increases the prices they pay for goods and services. A study by William Cline found that trade may have reduced low-wage workers' pay by about 3% during the 1970s and 1980s. However, a protectionist response sufficient to raise their wages by 3% would also raise import prices substantially and erode their purchasing power by 3%, leaving them no better off. Cline concludes: "Unskilled workers would have lost approximately as much from higher import prices as they would have gained from avoiding the downward pressure on their wages from import competition."
* Do Trade Deficits Destroy Jobs? Populist policy pronouncements equate trade deficits with lost jobs. For example, when Pat Buchanan ran for president in 1996, he declared: "Our merchandise trade deficit was $175 billion (in 1996). For every $1 billion, you get 20,000 jobs. That's 3.5 million American workers who would have had good manufacturing jobs if we simply had a trade balance."
The logic is simple--and simply wrong. If a trade deficit equated to lost jobs, then we should expect to see unemployment rise when the trade deficit rises and fall when the trade deficit falls. In fact, there is no relationship between the two. If anything, a larger trade deficit often accompanies lower unemployment. There are two possible reasons for this. First, as the American economy booms, Americans consume more, and hence they buy more imports. Second, a booming economy attracts investment from all over the world. When foreigners invest more in the United States, the trade deficit rises as the U.S. imports capital. Moreover, as the U.S. economy has become steadily more dependent on trade, there has been no discernible effect on the unemployment rate. Simplistic sound bites notwithstanding, increased trade does not mean decreased economic security.
* Trade Benefits Labor and the Environment. The principal rationale for including labor and environmental standards in trade pacts is that free trade could theoretically lead to a "race to the bottom" as poor countries sacrifice their environment and labor conditions in order to increase economic growth. Even if this happened, it's unclear why people in these countries should not be free to make that choice. However, a growing body of evidence suggests that trade liberalization leads to a "race to the top" rather than a "race to the bottom."
Labor standards: No `race to the bottom.' There are several reasons that free trade is unlikely to depress wages and working conditions:
* Although wages are lower in developing countries, the lower wages give them only a small advantage in attracting investment, because workers in developed countries are more productive. Economists Gary Hufbauer and Barbara Kotschwar note: "Because technological differences are so great, it turns out that unit labor costs are approximately the same in countries with vastly different wage levels, leaving firms in advanced countries with only weak incentives to relocate production to developing countries."
* Imports from developing countries (excluding oil and other natural resources) are equal to only 3% of developed countries' GDP. It is unlikely that such a small volume of trade has much effect on wages in developed countries.
* Trade creates wealth, which makes it possible to increase wages and working conditions in developing countries. Economic research shows that incomes in poor countries that are more open to trade grow faster than in poor countries that are more protectionist.
* Environment: A `race to the top.' Free trade can actually improve environmental quality by making societies wealthier. Experience shows that people want a cleaner environment as their incomes rise, and wealthier societies can afford to spend more on environmental protection.
A 1995 study by economists Gene Grossman and Alan Krueger examined the relationship worldwide between per capita GDP and measurements of air and water quality. Virtually all measures of air and water quality begin improving when annual per capita GDP rises above $8,000, and many improve at much lower levels of income. Once per capita income reaches $10,000-12,000, environmental quality is actually better than at lower income levels.
More recently, a National Bureau of Economic Research study examining pollution in 109 cities around the world found that a 1% increase in GDP due to trade liberalization leads to a 1% decrease in measured sulfur dioxide concentrations. Expanded economic activity places upward pressure on emissions, but the higher income made possible by trade liberalization has an even bigger effect in the opposite direction.
Labor and environmental standards both have a laudable objective: improving the quality of life for people in developing countries. But it is not clear that adding them to trade agreements is actually the most effective way to accomplish the goal. Trade negotiators can accomplish the same goal with less bureaucracy if they put aside nontrade agendas and strive for trade agreements that maximize economic growth.
RELATED ARTICLE: Protectionism in Sheep's Clothing?
The Clinton administration gave labor and environmental issues new status in trade negotiations when it attached labor and environmental provisions to the North American Free Trade Agreement (NAFTA). A country found to violate these provisions could find itself subject to import restrictions imposed by the other countries. Protectionists sought these measures to keep Mexico from using less stringent environmental or labor laws to gain a competitive advantage. Many free traders feared that adding such provisions to trade agreements would be a back door to protectionism.
The actual result is something that neither side predicted. NAFTA's environmental provisions have simply given political activists an additional lever to pursue their agendas. In the first four years of NAFTA, the majority of environmental complaints involved Canada and the United States, rather than Mexico. One group of activists took Canada to task for failing to enact endangered species legislation pursuant to the international Biodiversity Convention. Another tried to use the NAFTA process to address the effect of dams on fish habitat in British Columbia. On two occasions, environmental groups tried to overturn environmental provisions of the U.S. Rescission Act of 1995; their complaints were thrown out, because NAFTA allows countries to change their own environmental laws. Some of the Mexican cases, at least, deal with pollution, which was supposedly the big concern. But, on the whole, most of the environmental complaints seem only tangentially related to trade.
NAFTA's labor provisions involve a similar story, though here most of the complaints are against businesses operating in Mexico. Virtually all claim that some company denied workers the right to organize a union. Several cases involve either a company's or the Mexican government's refusal to certify an independent union unaffiliated with the country's dominant political party. Though the cause may evoke sympathy, the link to trade is tenuous.
Thus far, the NAFTA labor and environmental standards have not been used in a blatantly protectionist fashion. A big reason may be that they focus on encouraging each country to enforce its own laws, and they tend to focus on very basic goals like securing the right to organize labor unions. More wide-ranging requirements, such as minimum wage, hour, or benefit mandates, could create much more serious problems.…
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Publication information: Article title: Why Free Trade Is Good for Consumers. Contributors: Ellig, Jerry - Author. Magazine title: Consumers' Research Magazine. Volume: 83. Issue: 1 Publication date: January 2000. Page number: 19. © 1999 Consumers' Research, Inc. COPYRIGHT 2000 Gale Group.
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