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Who Benefits from Free Trade, and How

Mises Daily: Friday, January 23, 2004 by


The Internet has been abuzz lately with arguments over free trade. This most recent outburst of scholarship was sparked by Sen. Charles Schumer and economist Paul Craig Roberts' joint article in the New York Times, "Second Thoughts on Free Trade". In this article, Roberts reiterated his position that "the case for free trade" rests on the assumption that factors of production cannot move between countries (or at least, cannot move as easily as final products can).

According to Schumer and Roberts, in the modern world of multinational corporations, reduced shipping costs, and high-speed telecommunications, factors of production are quite mobile indeed. We can no longer be sure that "free trade" will work in the new environment. Rather than David Ricardo's classical law of comparative advantage (which showed that laborers in various countries will specialize in those industries in which they are relatively superior), which Roberts agrees will produce shared gains among all trading nations, in the new global economy we confront the law of absolute advantage: Capital and labor will move to those countries with the lowest costs of production, meaning some nations gain and others lose.

Naturally, libertarians went berserk over these claims. It certainly seemed as if Paul Craig Roberts were lending scholarly justifications for raising tariffs or other barriers on foreign imports to prevent American companies from "exporting jobs" to low-wage nations. I myself jumped on the bandwagon of criticizing the Schumer-Roberts piece, and engaged in an email correspondence with Roberts to boot. In response to these libertarian onslaughts, Roberts offered a blogged clarification of his position.

The present article is my attempt at a quick response to Roberts' clarifications. Naturally this article won't convince Roberts himself, but it may address the concerns of some who are still on the fence (and particularly those who emailed me in response to my linked article above).

Free Trade

First, let's be clear what I mean by free trade. When I say I'm "for free trade," that means I do not think the US government should impose tariffs or other barriers (such as import quotas) on the importation of foreign consumption goods by US consumers. Now it's true, I'm a philosophical anti-statist and so I oppose the very existence of the US federal government, but beyond that there are very practical reasons for being a free trader. Specifically, I believe that imposing tariffs makes Americans in general poorer. True, the workers in a "protected" industry may have higher wages than they otherwise would under free trade, but US consumers would be worse off because of higher prices. Most economists favor free trade because (at least under classical assumptions) when the government imposes a tariff, the monetary gains to the winners are outweighed by the monetary losses to the losers.

Roberts says that he agrees with this economic analysis in the case when capital goods cannot be easily shipped from one country to another. However, Roberts argues that the benefits of "free trade" do not necessarily hold when capital goods are mobile internationally. In his words, this possibility means that some countries gain and some lose.

Now here's the tricky point: I am claiming that even if it's true that the change from immobile to mobile factors of production "hurts" a given nation (which for a mainstream economist means that the average real income of people in a given nation goes down), this doesn't undermine the case for "free trade" unless we can show that a protective tariff or other barrier on imports would mitigate or eliminate this "hurting."

To use a silly analogy, it is certainly true that an earthquake in California hurts US citizens. In other words, Americans would be richer if there were no earthquake. But this doesn't undermine the case for free trade, because slapping on tariffs would make Americans even worse off. This is true even if the Americans would have been better off with no earthquake and a small tariff.

This is my position on free trade and factor mobility. Even if it's true that the change from immobile to mobile factors of production has made some countries poorer and others richer, unless you can demonstrate to me that the losing countries could have helped themselves by imposing tariffs, then this fact (i.e. that the change in mobility caused pain) does not at all undermine the case for free trade. Free trade is still the best policy. Imposing a tariff will still make the people in the "losing" country poorer on average, relative to how poor they would be with the change in factor mobility and free trade.

Innovation Can "Hurt"?

Before continuing, let me pause to address a certain issue. Perhaps the reader thinks I'm conceding too much to Roberts. After all, how can it be that improved shipping technology or data transmission can "hurt" a country? Sure, the workers in an obsolete job might be hurt, but consumers as a whole benefit, right?

Well, that's probably true empirically; I for one would definitely bet that Americans in general are richer because of, say, the Internet. But it is theoretically possible that the average real income in a small country might be reduced because of a technological innovation. For example, suppose that there is a small island nation in the Pacific composed of 10,000 people. Further suppose that these people are experts at building copy machines, and that their sole export is copy machines sent out to people in other countries.

Now, imagine that the advent of fax machines and email communications reduces the amount of paper copying that needs to be done. Office workers who formerly imported paper copiers from our hypothetical island—in order to make copies of important documents and send them to their associates in other countries, say—now can stop buying so many copiers. They just fax or email the relevant documents to their associates in other countries. Thus the international demand for copiers falls, and the 10,000 people on our hypothetical island now have to pick bananas instead of exporting copiers. Clearly they have been "hurt" by the improved technology.

How does this hypothetical example work? It concentrates the workers who are hurt by an innovation into one (imaginary) country, and lumps all of the beneficiary consumers into the rest of the world. Clearly average real incomes in the whole world have gone up because of faxing and emailing; the gains to the rest of the world outweigh the losses to the people who used to build copiers. But the point is, it's at least conceivable that a technological innovation could on net reduce the average real income in a given country. (For a different example, imagine if someone invented a way to cheaply make gourmet coffee out of rocks. This might make Brazilians poorer on average.)

Tariffs No Help

So back to the original argument: I'm saying that even in a case such as the one above, where an innovation actually hurts the average person in a country, it is still the case that a departure from free trade would have no effect at all, or would hurt this country even more.

In our case of the small island, it's obvious to see that a tariff on fax machines or computers wouldn't prevent the collapse of the domestic copier industry. It is foreign consumers who are switching to the new products (away from paper copiers), and so nothing the government of the small island does can stop that.

But what about cases where it is a country's own consumers who are switching allegiance to foreign, low-cost producers? For example, what happens when a US manufacturer fires US workers, physically moves his plant to Mexico, and hires Mexicans to produce the same product, which is then imported and sold to US consumers? Isn't it possible that a tariff on Mexican imports would prevent this, thus saving jobs?

Yes, a tariff on Mexican imports (if high enough) might convince the US capitalist to keep his plant in the US. But then that means prices would be higher for US consumers—that's how the tariff works, after all. In this case, where the consumers are located in the country we're considering, the only way trade policy will alter the situation is to make the consumers worse off. And as we've seen, the general rule is that a tariff hurts consumers more than it helps producers.

To summarize: If the benefiting consumers from an innovation are largely outside of a given country, then it is indeed true that the people in that country might actually be poorer as a result of the innovation. But in that case, no trade policy can change things. On the other hand, if enough of the benefiting consumers are inside a particular country, then the people in that country are helped (on net) by the innovation. Trade policy in this case can alter things (so that the new innovation is not exploited), but in that case people on net are poorer because of the tariff. In conclusion, no matter what the scenario, enacting tariffs can only make people poorer on average.

"Who's Talking About Tariffs?"

At this point, Paul Craig Roberts would go through the roof. As he has repeatedly emphasized, he is not arguing in favor of tariffs. All he is doing is pointing out that the case for free trade does not hold up when factors are mobile.

But this is why I belabored the definition of "free trade" in this context. If Roberts agrees that enacting tariffs or other barriers on foreign imports can never make Americans richer—whether factors are mobile or immobile—then we can stop arguing. In my book, this would be an admission on his part that a case (not Ricardo's) for free trade can still be made. (It might look like the case I made above, for example.)

In short, so long as Roberts agrees with me that placing tariffs or other barriers on foreign imports won't help Americans, then according to my definition he should stop saying he has "second thoughts on free trade."

Other Restrictions?

"But what about other government measures to prevent capital outflow?" the reader might ask. "Sure, tariffs aren't the answer—but Schumer and Roberts admit this in their article. We need to have an honest dialogue about how to prevent the outflow of capital goods from the US."

To this sort of argument, all I can say is this: Americans are not made richer when the government imposes artificial restrictions on the use of property. For example, if the government taxes all exported capital goods by 50%, that will certainly reduce the outflow of capital goods. But in these cases, one of three things will happen:

(1) Rather than moving manufacturing to another country (with lower costs) and reimporting the product to sell to American consumers at lower prices, manufacturers will now continue to produce domestically at higher costs. So the workers in those industries win but US consumers lose. It's the same as if the government imposed a tariff on the reimported products.

(2) Rather than making a good in a foreign country (at lower costs) and selling it to other countries at a given price, US companies will now continue to produce domestically at higher costs and sell the product to other countries for the same given price. In this case, the profits of US shareholders (i.e. owners of the capital goods) will be lower. The gains of US workers will be offset by losses of US capitalists. Now many egalitarians might like this outcome, but let's not kid ourselves that we're making America richer by it. You could just as well force every millionaire to pay someone $100/hour to cut his lawn and get the same result.

(3) Rather than shipping manufacturing to another country (with lower costs) in order to remain competitive in the world market, the tax on capital export might make the US capitalists keep their capital goods in the US and devote them to another line of production. (This is because, given US labor costs, they simply can't compete on the world market in the original industry.) In this case, the capital goods would have been diverted into less efficient lines of production, and thus their rental returns would be lower. I.e., the market value of the capital goods would drop because of the export tax. Without making ad hoc assumptions, it is hard to see how this will make Americans in general richer.

In conclusion, I don't believe that other possible measures to combat the alleged problem of mobile capital goods can help Americans in general. As with tariffs, certain groups might benefit, but again as with tariffs, the gains of the winners will be more than offset by the losses of the losers.

General Equilibrium

A frequent argument put forth by Roberts runs like this: Yes, everything the libertarians say is true, taken one at a time in a partial equilibrium context. Any given case of outsourcing will help American consumers more than it hurts the displaced American workers. But we can't assume that this will hold true once many industries start moving.

Why not? Roberts has not introduced externalities into his argument, so even on neoclassical terms why would, say, 1000 changes all of a sudden make Americans poorer, if everyone agrees that each change—considered one at a time—makes Americans richer?

The fallacy of composition works like this: It's true that if an individual at a football game stands up, he can see the game better. But if everyone stands up, nobody can see any better.

But this doesn't apply in the present case. If Roberts agrees that when Industry X outsources to Asia, US consumers benefit more than US workers lose, and if Roberts agrees that the same holds for Industries Y, Z, etc., then it's also true (without any further arguments about externalities) that even on neoclassical grounds, when all of these industries outsource, US consumers benefit more than US workers lose.

Now of course, the obvious retort will be: What happens when all of our industries are outsourced!! Then we'll be a nation of unemployed beggars, unable to afford any imports no matter how cheap!

But wait a second. If it's true that after Industries A, B, C, D, …, and Z outsource, then Americans are poorer than if all of those industries had remained in the US, then it must be true (again, without an argument concerning externalities that Roberts certainly hasn't advanced) that at some point, the outsourcing of a particular industry made Americans poorer on average. Let's say it's Industry J. So in other words, Roberts has been backed into a corner arguing, ‘It's fine if Industries A through I move to Asia, but after that America would have been better off if Industries J through Z remained in the US.'

If this is indeed true, then guess what? That's exactly what will happen on the free market. Manufacturing operations will continue to move to other countries until that point at which it is no longer efficient for them to do so. And along the way to this point, each step (as Roberts concedes) makes Americans on net wealthier, so that means the whole process makes Americans a lot wealthier (on net) than if we tried to prevent the outsourcing in the first place.

(To understand what would prevent the outsourcing at some point, keep in mind that "cheap" foreign labor would no longer be so cheap after nominal wages changed and/or exchange rates changed in response to the continual outsourcing. Yes, the actual dollar amount of the average American's salary might be lower, but his standard of living would be higher because of all the new, cheap imports due to outsourcing.)


Before I wrap up this behemoth of an article, let me address three final issues. One is this: If somebody wants to up and leave the US because he or she perceives a better life elsewhere, then of course in this sense increased mobility might make the US poorer. For example, if Bill Gates all of a sudden says, "I'm going to move to Hong Kong because now it's pretty easy to ship my favorite mansion over there," then his exit would lower the average income of (remaining) US citizens. If this is all people are talking about, then fine. In this type of case, I would of course say that a person's liberty to leave the country should not be sacrificed to the goal of propping up a statistical figure.

Another issue is slavery. People email me and say, "Your theories would be true if everyone had a free market, but China employs slave labor."

Okay, this is a valid point. If you don't want to indirectly encourage slave labor, then by all means, don't buy products that may have been produced under not entirely voluntary circumstances. All I'm claiming here, though, is that don't kid yourself that you're making yourself wealthier by doing so. If you choose to buy a product from a US firm for $10 that you could import from Asia for $5, then you're down $5 on the decision. Of course, maybe that's what you want to do; more power to you. But don't think you're making America "richer," and don't run to the government to force your decision on the rest of us.

Finally, let me concede that the above arguments are not rigorous enough for publication in a mainstream economics journal. Paul Craig Roberts has repeatedly claimed that libertarians are arguing with "economic theory" and not him per se. He has even said that if we're right, then we should publish our case and win the Nobel Prize.

Well, I don't know enough about modern trade theory to evaluate his claims. But if it turns out that a mathematical model based on the above musings is worthy of a Nobel . . . hey, I could use a million bucks. (You know how many TVs you can import with that kind of money?)

