Tariffs and standards: Towards a new trade policy

On January 23, 2017, President Donald Trump signed an order directing the US Trade Representative to withdraw the country from the Trans-Pacific Partnership (TPP), the trade deal that the previous administration had spent years negotiating with eleven other nations around the Pacific Rim. This executive action represents a first step towards a controversial new direction in trade policy.

The TPP was already on life support, as the 2016 election campaign made it toxic with the majority of American voters. Bernie Sanders, Ted Cruz and Donald Trump all focused great energy on the trade pact as an example of the failed economic policies of recent decades. Even Hillary Clinton, despite her previous public support for the TPP and other trade agreements, was forced to come out against it, to fight off criticism from Sanders in the primaries, and Trump in the general election.

A recipe for disaster 

Trump’s broadsides against international free trade deals have provoked a response bordering on horror from much of the political and academic world. The dreaded policies of “protectionism”, which economists left and right assure are a recipe for disaster, seem to be on the march, threatening to return the world to a terrible past when governments intervened too much in economic policy.

More sophisticated commentators prefer to focus on the strategic ramifications of abandoning the TPP. Indeed it is no secret that the principal goal of the pact was geopolitical, to strengthen ties with Western allies around the world and prevent other countries from falling under China’s sphere of influence. Former President Barack Obama often repeated that the TPP would ensure that “we write the rules of the road for trade in the 21st century.” The American population was not convinced.

This should have come as no surprise to the nation’s political institutions, but the assumption apparently was that, as has generally happened in the past, the politicians of both parties would come together to move forward the “Washington Consensus” that had dominated economic policy-making for decades.

Yet opposition was strong, from unions and progressives in particular. This forced Democratic leaders to come up with justifications for yet another deal suspected of favoring outsourcing to low-cost countries, and protecting the profits of multinational corporations at the expense of the American worker.

The Obama administration made assurances that the TPP had “the toughest labor and environmental standards that have ever been included in a trade deal.” And despite later attempts to walk back her praise, in 2012 then Secretary of State Hillary Clinton famously said, “This TPP sets the gold standard in trade agreements to open free, transparent, fair trade.”

Jobs, trade and technology

Few people believed this rhetoric: not progressives, not conservatives, not workers whether on the left or right. And why should they have? Total US manufacturing employment has dropped by more than seven million jobs since 1980, even as total population has grown by almost 100 million individuals. In percentage terms, manufacturing employees now make up only 8% of the workforce, about one-third of their weight in 1970. It is well known that most of these workers now find themselves with jobs that pay less in real terms and provide less stability, if they have not fallen out of the workforce altogether.

One response to this phenomenon increasingly heard from experts is that the loss of industrial jobs is due not to trade, but technology. Automation is accelerating and promises to do so even more with the digital revolution. The trend towards producing more with fewer workers is irreversible. However, for high-technology goods in particular, this can actually favor reshoring, as cost of labor becomes less important, while worker skills and a climate of innovation represent strategic advantages.

As for more labor-intensive goods, the argument seems specious when used to justify free trade agreements. Why is it that most of the consumer products bought, both in the US and Europe, are produced in countries like China, Bangladesh, Mexico or Guatemala? Technology doesn’t provide the answer; low wages and operating costs do.

A more coherent argument is that regarding prices. It is said that in many sectors labor-intensive production processes are simply too costly to remain in more advanced countries, and thus free trade keeps prices down. What would consumers at the bottom of the economic ladder say if they could not get cheap goods at Wal-Mart?

Low cost vs. well-being

This is a real problem, which raises complex issues about how to reverse the race to the bottom based on low costs, but the perspective can be shifted quickly by taking a more long-term view: why is it that the (working) poor in the US cannot afford higher-priced goods? Does it not have something to do precisely with the loss of good-paying jobs due to the search for cheap labor? A quick glance around the world shows the weakness of the argument for low costs as essential for economic well-being. The wealthiest economies are not characterized by low costs; quite the opposite.

Proponents of pro-free trade policies propose various arguments to counter the opposition to outsourced production. Again though, the population is unlikely to believe them. And again, why should they? The contradictions are all too apparent.

By way of example, consider the arguments presented by Mireya Solís in her article “The case for trade and the Trans-Pacific Partnership” published by the Brookings Institute in October 2016 as part of the “Brookings Big Ideas for America” initiative.[1]

Solís is up front when she asserts the importance of the TPP as an instrument to counter China’s weight in Asia. When it comes to jobs though, she runs into a blatant contradiction in her attempt to claim that on the whole, the new trade deal will be good for America. After admitting that trade competition with China “is estimated by some to have cost 985,000 manufacturing jobs between 1999 and 2011,” she moves quickly to stress other factors (technology, exports, low prices) to downplay the importance of this loss. One paragraph later, though, Solís is glad to tell us that the International Trade Commission has estimated that the TPP would create 128,000 jobs in the US

Not a very strong argument, at least in mathematical terms.

Recognition is in fact growing in the academic world of the difficulties for the optimistic view that losses due to low-cost competition are generally outweighed by positive factors in advanced countries. An example is the in-depth study, “The China Shock: Learning from Labor-Market Adjustment to Large Changes in Trade,” by Autor, Dorn and Hanson.[2]

The authors note that in the 1990s and early 2000s, a consensus had been reached, for example, that “Trade had not in recent decades been a major contributor to declining manufacturing employment or rising wage inequality in developed countries.” Technological change was viewed as the primary factor at work, while the fluid and flexible US labor markets were expected to absorb the shocks from trade with China and produce increases in employment in other industries.

Yet new studies are showing that the anticipated adjustment is not offsetting negative effects on jobs and income; the positive gains posited by neoclassical theory “have yet to materialize”. In fact, the authors conclude, the effects produced by growth of imports may even have been underestimated. While positive employment effects are “plausible in theory”, evidence in academic literature is scarce.

The (dis)harmony of interests 

In 1851, American economist Henry Carey wrote his seminal work, “The Harmony of Interests.” Carey’s ideas would form the basis for the economic program of the newly-founded Republican Party led by Abraham Lincoln, and the global expansion of what became known as the “American System”, based on protection, investment in industry, infrastructure and workers.

In his book, Carey expressed a view that is still relevant today: in the long run either the condition of the exploited laborers throughout the world would be raised and move towards that of the more developed nations, or the American worker would ultimately be brought down to the level of the laborer under the imperial system.

Carey’s central premise is that “every man is a consumer to the whole extent of his production,” meaning that if you produce something, you will have the income necessary to consume as well, which will actually increase trade. This idea would undoubtedly be considered terribly outdated by most economists today. Yet for American and European workers who have lived through the recent phase of globalization, it is all too accurate.

However, few seem able to translate their recognition of the negative effects on American workers into a new set of policies, something that can replace the free trade, globalization mindset of the past 30+ years. Both the left and right have cheered campaigns against global trade pacts, but for many the word “protectionism” still seems a bridge too far.

Need for a new theory

A new approach to trade policy is needed, to begin the fundamental shift away from the low-cost, anti-production policies of recent decades. Below are some specific measures that could be taken to start the change, drawing on concepts already present in the political debate that, however, represent a move away from the current system.

First of all, let us consider tariffs. Tariffs and duties are currently used by many countries, justified in the West, for example, as measures to counteract dumping. This practice is generally defined as selling below the “normal price”, i.e. below cost or below the price in the home market.

The first order of business for countries with developed economies and social welfare systems is to define clear rules concerning social dumping – the broader definition of production practices taking advantage of cheap labor – and protections to avoid it.

President Trump and some of his advisors have suggested imposing significant tariffs on goods from other countries, starting with Mexico. The notion of a “border tax” for American companies that outsource their production and then re-import finished products makes sense, but needs to be implemented with clear standards. Here are some suggestions for how it could work.

First, the obvious target is companies that move production abroad but at the same time receive tax breaks and other incentives from the federal and local governments. The infamous case of Carrier in Indiana is quite clear: a company that received more than $500,000 in grants from the state, and applied for more than $5 million in federal tax breaks, but then decided to move its production to take advantage of cheap labor elsewhere. Public pressure forced Carrier to claim it would not take the federal incentives, but laws could be passed to prevent companies that outsource production from benefitting from public funds.

Second, the type of standards included in previous free trade agreements, but rarely implemented, should be strengthened, adopted as national policy and enforced unilaterally where possible.

Under NAFTA, for example, the protection of labor standards is governed by the North American Agreement on Labor Cooperation (NAALC) that entered into force along with NAFTA itself. The NAALC covers areas such as the prohibition of forced labor, minimum employment standards, prevention of occupational injuries, and the elimination of employment discrimination. Yet the agreement is widely viewed as having been ineffective, due to lack of enforcement.[3] The end-result of petitions filed through the NAALC process, for the few that actually move forward, is the creation of a committee that in the best of cases has led to public awareness campaigns, rather than hard sanctions or policy responses.

Subsequent trade pacts have also contained labor-protection provisions, and as noted, the proponents of the TPP have spoken glowingly about its labor and environmental protections. If this is truly among the aims of free trade agreements, then there should be no opposition to such provisions becoming an integral part of US trade laws, and being included in any bilateral agreements concluded in the future.

The goal is not to close borders and restrict trade, but to ensure that trade takes place without undermining the social and living standards of developed countries. Regulations need to be drawn up to certify whether companies, or entire countries, comply with certain standards. Some examples include rules on workplace safety, child labor and pollution, which can be enforced through both tariffs and in some cases outright bans.

Selective targeting of low-quality production will be complex at times, in part due to the existence of global supply chains, which exploit comparative advantages in terms of not only labor costs, but also logistics and infrastructure. Yet the complexity of these issues is no excuse for ignoring the enforcement of provisions that are essential to protect economic well-being. Politicians and economists constantly make assurances that such standards are integral to the notion of free trade, yet on the list of priorities they seem to be squarely at the bottom.

Seize the day 

The current political situation offers an opportunity to chart a new course, not of isolationism, but of setting clear rules for trade between countries aiming for high living standards.

The TPP is dead, as is the TTIP between the United States and Europe. However, there will likely be a move to pursue the key objectives of those pacts, such as strategic positioning towards China and protection of intellectual property rights, through bilateral agreements with a number of countries. Such agreements would be an excellent place to show that the US is now ready to enforce standards consistent with the living conditions in advanced economies, while still pursuing mutually beneficial trade. The practical effect could be that the key parameters of trade will shift from low costs, to high quality; precisely what is needed to respond to the race to the bottom that has so negatively affected the middle class in the advanced economies of the West.

 

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[1] Solís, Mireya, The case for trade and the Trans-Pacific Partnership. Brookings Big Ideas for America, October 4, 2016.

[2] Autor, David H., Dorn, David, Hanson, Gordon H., The China Shock: Learning from Labor-Market Adjustment to Large Changes in Trade. Annual Review of Economics, 2016. 8:205–40.

[3] Bieszczat, Frank H., Labor Provisions in Trade Agreements: From the NAALC to Now. Chicago-Kent Law Review, Volume 83, June 2008.