Is Free Trade Really Good for Everyone?

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on May 15, 2015 2:17:00 PM

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free tradeAs I noted yesterday, President Obama and Mitch McConnell, the Senate majority leader, are working to move a new free trade agreement through Congress, based on a shared conviction that it is good for the country. Many Democrats, who do not share that conviction, are fighting it.

To understand what the stakes are here, and what the different sides are fighting for, let’s take a deeper look at how free trade works and how its benefits are distributed.

Comparative advantage in a nutshell

The notion of comparative advantage is fundamental to the case for free trade. The idea is that if a carpenter is good at making chairs and a baker good at making bread, they both do better if they can concentrate on what they’re good at. At the end of the day, we have more bread and more chairs than if the carpenter tried to bake and the baker tried to build.

This idea extends to countries as well. A country with a surplus of labor (China) would focus on labor-intensive manufacturing, while a country with a focus on design and research (the U.S.) could get on with that. The end result, as we’ve seen over the past 20 years, is more, and much cheaper, goods. The large-screen TV you just bought is proof the idea works.

Here’s the problem

There are two hidden factors, though, that are becoming more apparent:

  • First, as the capabilities of different countries converge—as China moves up the value chain and engages in more complex design and research—the relative differences start to disappear, as does the comparative advantage.
  • Second, comparative advantage doesn’t dictate how the benefits of free trade are distributed.

China has made a concerted effort to move from cheap, simple goods to complex, expensive ones, from shoes to cars and computers. As it does, it competes more directly with the U.S., starting to take away not only low-wage jobs but also high-paying ones that we really don’t want to lose.

China has no choice in this; that huge supply of labor is starting to shrink, and moving up the value chain is the only way it can continue to grow. At the same time, the advantage to the U.S. disappears if China is doing the same things we do.

Of course, losing low-paying jobs is also problematic. For the Americans who saw their jobs offshored to cheaper Chinese labor, this has been a huge issue, one that the U.S. hasn’t done a great job of solving. The benefits, in the form of cheaper TVs and other goods, have been widespread. The costs have been much more focused.

Jobs, jobs, jobs

It is this conflict—between the apparently diminishing benefits and the rising costs, as job competition moves into the more politically powerful middle classes—that is driving the debate over free trade. The reality is that, overall, there are significant benefits, but also significant costs. We will talk more about both in the next couple of posts.

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