Free and balanced trade

In last night’s debate, President Obama and Governor Romney both emphasized that job one for them is to create jobs. Yet despite complaints about Chinese trade practices both are also pledged more of the free trade/globalization deals that have already contributed to chronic U.S. trade deficits, the off-shoring of 3-5 million jobs, and the recent Great Recession that is now threatening a second dip. Obviously neither of them understands what’s really happening in the global economy.

Since both are proposing various kinds of Keynesian economic stimulus programs, both should also read John Maynard Keynes’ views on globalization. A devotee of classical free trade as a young economist, Keynes became convinced by the experience of the Great Depression of the 1930s of the overriding importance of nations achieving balanced trade and avoiding large international debts. At the 1944 Bretton Woods Conference, he urged not only that a new international facility be designated as the lender of last resort to deficit countries, but also called for the imposition of temporary tariffs on the exports of countries with chronic trade surpluses in order to create pressure for balance in the trading system.

Then a surplus country, the United States defeated the tariff idea. However, since the 1970s when America developed a chronic trade deficit, U.S. negotiators have constantly complained of unfair trade and have striven to create a "level playing field." They never have and never will succeed because the World Trade Organization ( WTO), the International Monetary Fund (IMF), and the various Free Trade Agreements (FTAs) were never empowered to deal with the realities of globalization that Keynes foresaw.

For more than sixty years, leaders of both the Republican and Democratic parties have embraced the neo-classical textbook doctrine of free trade as always and everywhere a win-win game. It was on this basis that they led the establishment of the World Trade Organization (WTO) and have continued to negotiate a variety of bi-lateral and regional free trade agreements. In the textbooks, free trade is always win-win because all markets are assumed to be perfectly competitive (no single producer has any measureable impact on the amount of total production or on global prices -e.g. wheat), there are no economies of scale, no unemployment, no international flows of investment or technology, no manipulations of currency values, no subsidies for key industries, no special incentives for saving and investment, no administrative guidance or discriminatory support for indigenous technology development, and no export subsidies.

These assumptions may have approximated reality in an earlier age. But today, it is imperfect competition in oligopoly industries with few entrants and big economies of scale (autos, aircraft, semiconductors), huge global investment and technology flows, state owned enterprises, and government intervention in a wide variety of areas that predominate. In this framework, whether or not free trade and globalization are win-win or zero sum games depends on circumstances, and strategic economic policies can determine whether a nation wins or loses.

Indeed, virtually all the "economic miracle" nations have adopted government led economic development strategies. A bi-furcated global system has evolved in which half the players are roughly pursuing textbook free trade while the other half are engaged in neo-mercantilist targeting of strategic industry development and export led growth. This has led to the large imbalances and debt that Keynes so much feared. Countries like Germany and China perennially suppress household income and consumption, save and invest heavily, undervalue their currencies, provide support to targeted industries, promote export led growth, and accumulate chronic trade (technically current account) surpluses. Countries like the United States and Britain emphasize domestic consumption as the driver of economic growth, tend to under-save and invest, to have over-valued currencies (driven by the exporters’ currency manipulation), to consume more than they produce, and to accumulate chronic trade deficits. The surpluses of the exporters slosh around global financial markets to finance the deficits of the importers in a kind of vendor financing scheme. In doing so, they distort interest and exchange rates while giving rise to destabilizing speculation, reckless lending, and the expansion of bubbles whose collapse eventually results in crises and recessions.

At present, the job creation strategy of the German dominated Euro Zone, the bulk of the Asians, and of most of the Latin American countries is export led growth, with America and, to a lesser extent, the UK as the buyers of last resort. In the face of this, traditional free trade policies will only produce continued off-shoring of jobs. Efforts to stem this with more stimulus or tax cuts will falter because much of this new money will leak abroad to buy foreign exports.

Obama and Romney both need to think outside the orthodox free trade box. That doesn’t mean turning to protectionism, but it does mean dealing with the real rather than the textbook world and emphasizing balanced as well as free trade. They should be setting targets and plans for reducing U.S. trade deficits through a combination of production in-shoring and export doubling. After all, even halving the U.S. trade deficit would create 2-3 million jobs.