As longtime readers of this blog know, it’s not uncommon for
the essays I post here to go veering off on an assortment of tangents, and this
week’s post is going to be an addition to that already well-stocked list. Late
last week, as the aftermath of the recent election was still spewing all over
the media, I was mulling over one likely
consequence of the way things turned out—the end of at least some of the free
trade agreements that have played so large and dubious a role in recent
economic history
One of the major currents underlying 2016’s political
turmoil in Europe and the United States, in fact, has been a sharp disagreement
about the value of free trade. The political establishment throughout the
modern industrial world insists that free trade policies, backed up by an
ever-increasing network of trade agreements, are both inevitable and inevitably
good. The movements that have risen up against the status quo—the Brexit
campaign in Britain, the populist surge that just made Donald Trump the next US
president, and an assortment of similar movements elsewhere—reject both these
claims, and argue that free trade is an unwise policy that has a cascade of
negative consequences.
It’s important to be clear about what’s under discussion
here, since conversations about free trade very often get wrapped up in warm
but vague generalities about open borders and the like. Under a system of free
trade, goods and capital can pass freely across national borders; there are no
tariffs to pay, no quotas to satisfy, no capital restrictions to keep money in
one country or out of another. The so-called global economy, in which the
consumer goods sold in a nation might be manufactured anywhere on the planet,
with funds flowing freely to build a factory here and funnel profits back
there, depends on free trade, and the promoters of free trade theory like to
insist that this is always a good thing: abolishing trade barriers of all
kinds, and allowing the free movement of goods and capital across national
boundaries, is supposed to create prosperity for everyone.
That’s the theory, at least. In practice? Well, not so much. It’s not always remembered
that there have been two great eras of free trade in modern history—the first
from the 1860s to the beginning of the Great Depression, in which the United
States never fully participated; the second from the 1980s to the present, with
the United States at dead center—and neither one of them has ushered in a world
of universal prosperity. Quite the contrary, both of them have yielded
identical results: staggering profits for the rich, impoverishment and
immiseration for the working classes, and cascading economic crises. The first
such era ended in the Great Depression; the second, just at the moment, looks as
though it could end the same way.
Economists—more precisely, the minority of economists who
compare their theories to the evidence provided by the real world—like to
insist that these unwelcome outcomes aren’t the fault of free trade. As I hope
to show, they’re quite mistaken. An important factor has been left out of their
analysis, and once that factor has been included, it becomes clear that free
trade is bad policy that inevitably produces poverty and economic instability,
not prosperity.
To see how this works, let’s imagine a continent with many
independent nations, all of which trade with one another. Some of the nations
are richer than others; some have valuable natural resources, while others
don’t; standards of living and prevailing wages differ from country to country.
Under normal conditions, trade barriers of various kinds limit the flow of
goods and capital from one nation to another.
Each nation adjusts its trade policy to further its own economic interests. One nation that’s trying to build up a
domestic steel industry, say, may use tariffs, quotas, and the like to shelter
that industry from foreign competition.
Another nation with an agricultural surplus may find it necessary to
lower tariffs on other products to get neighboring countries to buy its grain.
Outside the two eras of free trade mentioned above, this has
been the normal state of affairs, and it has had two reliable results. The
first is that the movement of goods and capital between the nations tends
toward a rough balance, because every nation uses its trade barriers to police
hostile trade policy on the part of its neighbors. Imagine, for example, a
nation that tries to monopolize steel production by “dumping”—that is, selling
steel on the international market at rock-bottom prices to try to force all
other nations’ steel mills into bankruptcy. The other nations respond by
slapping tariffs, quotas, or outright bans on imported steel from the dumping
country, bringing the project to a screeching halt. Thus trade barriers tend to
produce a relative equilibrium between national economies.
Notice that this is an equilibrium, not an equality. When
trade barriers exist, it’s usual for some nations to be rich and others to be
poor, for a galaxy of reasons having nothing to do with international trade. At
the same time, the difficulties this imposes on poor nations are balanced by a
relative equilibrium, within nations, between wages and prices.
When the movement of goods and capital across national
borders is restricted, the prices of consumer products in each nation will be
linked via the law of supply and demand to the purchasing power of consumers in
that nation, and thus to the wages paid by employers in that nation. Of course
the usual cautions apply; wages and prices fluctuate for a galaxy of reasons,
many of which have nothing to do with international trade. Even so, since the
wages paid out by employers form the principal income stream that allows
consumers to buy the employers’ products, and consumers can have recourse to the
political sphere if employers’ attempts to drive down wages get out of hand,
there’s a significant pressure toward balance.
Given trade barriers, as a result, people who live in
countries that pay low wages generally pay low prices for goods and services,
while people who live in countries with high wages face correspondingly high
prices when they go shopping. The low prices make life considerably easier for
working people in poor countries, just as the tendency of wages to match prices
makes life easier for working people in rich countries. Does this always work?
Of course not—again, wages and prices fluctuate for countless reasons, and
national economies are inherently unstable things—but the factors just
enumerated push the economy in the direction of a rough balance between the
needs and wants of consumers, on the one hand, and their ability to pay, on the
other.
Now let’s imagine that all of the nations we’ve imagined are
convinced by a gaggle of neoliberal economists to enact a free trade zone, in
which there are no barriers at all to the free movement of goods and capital.
What happens?
When there are no trade barriers, the nation that can
produce a given good or service at the lowest price will end up with the lion’s
share of the market for that good or service. Since labor costs make up so
large a portion of the cost of producing goods, those nations with low wages
will outbid those with high wages, resulting in high unemployment and
decreasing wages in the formerly high-wage countries. The result is a race to
the bottom in which wages everywhere decline toward those of the worst-paid
labor force in the free trade zone.
When this happens in a single country, as already noted, the
labor force can often respond to the economic downdraft by turning to the
political sphere. In a free trade zone, though, employers faced with a
political challenge to falling wages in one country can simply move elsewhere.
It’s the mismatch between economic union and political division that makes free
trade unbalanced, and leads to problems we’ll discuss shortly.
Now of course free trade advocates like to insist that jobs
lost by wealthier nations to poorer ones will inevitably be replaced by new
jobs. History doesn’t support that claim—quite the contrary—and there are good
reasons why the jobs that disappear will never be replaced. In a free trade
system, it’s more economical for startups in any labor-intensive industry to go
straight to one of the countries with low wages; only those industries that are
capital-intensive and thus employ comparatively few people have any reason to
get under way in the high-wage countries. The computer industry is a classic
example—and you’ll notice, I trust, that just as soon as that industry started
to become labor-intensive, it moved offshore. Still, there’s another factor at
work.
Since wages are a very large fraction of the cost of
producing goods, the overall decrease in wages brings about an increase in
profits. Thus one result of free trade is a transfer of wealth from the laboring
majority, whose income comes from wages, to the affluent minority, whose income
comes directly or indirectly from profits. That’s the factor that’s been left
out of the picture by the proponents of free trade—its effect on income
distribution. Free trade makes the rich richer and the poor poorer, by
increasing profits while driving wages down. This no doubt explains why free
trade is so popular among the affluent these days, just as it was in the
Victorian era.
There’s a worm in the bud, though, because a skewed income
distribution imposes costs of its own, and those costs mount up over time in
painfully familiar ways. The difficulty with making the rich richer and the
poor poorer, as Henry Ford pointed out a long time ago, is that the wages you pay
your employees are also the income stream they use to buy your products. As
wages decline, purchasing power declines, and begins to exert downward pressure
on returns on investment in every industry that relies on consumer purchases
for its income.
Doesn’t the increasing wealth of investors counterbalance
the declining wealth of the wage-earning masses? No, because the rich spend a
smaller proportion of their incomes on consumer goods than the poor, and divert
the rest to investments. Divide a million dollars between a thousand working
class family, and the money’s going to be spent to improve the families’
standard of living: better food, a bigger apartment, an extra toy or two around
the Christmas tree, and so on. Give the same million to one rich family and
it’s a safe bet that much of it’s going to be invested.
This, incidentally, is why the trickle-down economics
beloved of Republican politicians of an earlier era simply doesn’t work, and
why the Obama administration’s massive handouts of government money to banks in
the wake of the 2008-9 financial panic did so little to improve the financial
condition of most of the country. When it comes to consumption, the rich simply
aren’t as efficient as the poor. If you want to kickstart an economy with consumer
expenditures, as a result, you need to make sure that poor and working class
people have plenty of money to spend.
There’s a broader principle here as well. Consumer expenditures and capital for
investment are to an economy what sunlight and water are to a plant: you can’t
substitute one for the other. You need both. Since free trade policies funnel
money away from expenditure toward investment by skewing the income
distribution, it causes a shortage of the one and a surplus of the other. As
the imbalance builds, it becomes harder for businesses to make a profit because
consumers don’t have the cash to buy their products; meanwhile the amount of
money available for investment increases steadily. The result is a steady
erosion in return on investment, as more and more money chases fewer and fewer
worthwhile investment vehicles.
The history of free-trade eras is thus marked by frantic
attempts to prop up returns on investment by any means necessary. The
offshoring fad that stripped the United States of its manufacturing economy in
the 1970s had its exact equivalent in the offshoring of fabric mills from
Britain to India in the late Victorian era; in both cases, the move capitalized
on remaining disparities in wages and prices between rich and poor areas in a
free trade zone. In both cases, offshoring worsened the problem it was meant to
fix, by increasing the downward pressure on wages in the richer countries and
further decreasing returns on investment across the entire spectrum of consumer
industries—then as now, the largest single share of the economy.
A gambit that as far as I know wasn’t tried in the first era
of free trade was the attempt to turn capital into ersatz income by convincing
consumers to make purchases with borrowed money. That’s been the keystone of
economic policy in the United States for most of two decades now. The housing bubble was only the most
exorbitant manifestation of a frantic attempt to get people to spend money they
don’t have, and then find some way to pay it all back with interest. It hasn’t
worked well, not least because all those interest payments put an additional
downward pressure on consumer expenditures.
A variety of other, mostly self-defeating gimmicks have been
put in play in both of the modern free trade eras to try to keep consumer
expenditures high while wages decline. None of them work, because they don’t
address the actual problem—the fact that under free trade, the downward
pressure on wages means that consumers can’t afford to spend enough to keep the
economy running at a level that will absorb the available investment
capital—and so the final solution to the problem of declining returns on
investment arrives on schedule: the diversion of capital from productive
investment into speculation.
Any of my readers who don’t know how this story ends should
get up right now, and go find a copy of John Kenneth Galbraith’s classic The
Great Crash 1929. Speculative bubbles, while they last, produce abundant
returns; when free trade has driven down wages, forced the consumer economy
into stagnation or contraction, and decreased the returns on investment in
productive industries to the point of “why bother,” a speculative bubble is
very often the only profitable game in town. What’s more, since there are so
few investments with decent returns in the late stages of a free trade scheme,
there’s a vast amount of money ready to flow into any investment vehicle that
can show a decent return, and that’s exactly the environment in which
speculative bubbles breed most readily.
So the great free trade era that began tentatively with the
repeal of the Corn Laws in 1846, and came into full flower with Gladstone’s
abolition of tariffs in 1869, ended in the stock market debacle of 1929 and the
Great Depression. The road there was littered with plenty of other crises, too.
The economic history of the late nineteenth and early twentieth centuries is a
cratered moonscape of speculative busts and stock market crashes, culminating
in the Big One in 1929. It resembles, in fact, nothing so much as the economic
history of the late twentieth and early twenty-first centuries, which have had
their own sequence of busts and crashes: the stock market crash of 1987, the
emerging markets crash of 1994, the tech-stock debacle of 2000, the housing bust
of 2008, and the beat goes on.
Thus free trade causes the impoverishment and immiseration
of the labor force, and a cascading series of economic busts driven by the
mismatch between insufficent consumption and excess investment. Those problems
aren’t accidental—they’re hardwired into any free trade system—and the only way
to stop them in their tracks is to abandon free trade as bad policy, and
replace it with sensible trade barriers that ensure that most of the products
consumed in each nation are made there.
It’s probably necessary to stop here and point out a couple
of things. First of all, the fact that free trade is bad policy doesn’t mean
that every kind of trade barrier is good policy. The habit of insisting that the only possible
points along a spectrum are its two ends, common as it is, is an effective way
to make really bad decisions; as in most things, there’s a middle ground that
yields better results than either of the two extremes. Finding that middle
ground isn’t necessarily easy, but the same thing’s true of most economic and
political issues.
Second, free trade isn’t the only cause of economic
dysfunction, nor is it the only thing that can cause skewed income distribution
and the attendant problems that this brings with it. Plenty of factors can
cause a national or global economy to run off the rails. What history shows
with painful clarity is that free trade inevitably makes this happen. Getting
rid of free trade and returning to a normal state of affairs, in which nations
provide most of their own needs from within their own borders and trade with
other nations to exchange surpluses or get products that aren’t available at
home readily, or at all, gets rid of one reliable cause of serious economic
dysfunction. That’s all, but arguably it’s enough to make a movement away from
free trade a good idea.
Finally, the points I’ve just made suggest that there may be
unexpected benefits, even today, to a nation that extracts itself from free
trade agreements and puts a well-planned set of trade restrictions in place.
There are plenty of factors putting downward pressure on prosperity just now,
but the reasoning I’ve just sketched out suggests that the destitution and
immiseration so common in the world right now may have been made considerably
worse than they would otherwise be by the mania for free trade that’s been so
pervasive in recent decades. A country that withdraws from free trade
agreements and reorients its economy for the production of goods for domestic
consumption might thus expect to see some improvement, not only in the
prosperity of its working people, but in rates of return on investment.
That’s the theory I propose. Given the stated policies of
the incoming US administration, it’s about to be put to the test—and the
results should be apparent over the next few years.
****************
On a different and less theoretical note, I’m delighted to report that the third issue of Into The
Ruins, the quarterly magazine of deindustrial science fiction, is on its way to subscribers and available for sale to everyone else. The Fall 2016 issue includes stories by regular authors and newcomers alike, including a Matthew Griffiths tale set in the universe of my novel Star’s Reach, along with book reviews, essays, and a letter to the editors column that is turning into one of the liveliest forums in print. If you’re not subscribing yet, you’re missing a treat.
