THE CASE FOR FREE TRADE (Milton Friedman)

It is often said that bad economic policy reflects disagreement among the experts; that if all economists gave the same advice, economic policy would be good. Economists often do disagree, but that has not been true with respect to international trade. Ever since Adam Smith there has been virtual unanimity among economists, whatever their ideological position on other issues, that international free trade is in the best interests of trading countries and of the world. Yet tariffs have been the rule. The only major exceptions are nearly a century of free trade in Great Britain after the repeal of the Corn Laws in 1846, thirty years of free trade in Japan after the Meiji Restoration, and free trade in Hong Kong under British rule. The United States had tariffs throughout the nineteenth century, and they were raised still higher in the twentieth century, especially by the Smoot-Hawley tariff bill of 1930, which some scholars regard as partly responsible for the severity of the subsequent depression. Tariffs have since been reduced by repeated international agreements, but they remain high, probably higher than in the nineteenth century, though the vast changes in the kinds of items entering international trade make a precise comparison impossible.

Today, as always, there is much support for tariffs--euphemistically labeled "protection," a good label for a bad cause. Producers of steel and steelworkers' unions press for restrictions on steel imports from Japan. Producers of TV sets and their workers lobby for "voluntary agreements" to limit imports of TV sets or components from Japan, Taiwan, or Hong Kong. Producers of textiles, shoes, cattle, sugar--they and myriad others complain about "unfair" competition from abroad and demand that government do something to "protect" them. Of course, no group makes its claims on the basis of naked self-interest. Every group speaks of the "general interest," of the need to preserve jobs or to promote national security. The need to strengthen the dollar vis-à-vis the deutsche mark or the yen has more recently joined the traditional rationalizations for restrictions on imports.

One voice that is hardly ever raised is the consumer's. That voice is drowned out in the cacophony of the "interested sophistry of merchants and manufacturers" and their employees. The result is a serious distortion of the issue. For example, the supporters of tariffs treat it as self evident that the creation of jobs is a desirable end, in and of itself, regardless of what the persons employed do. That is clearly wrong. If all we want are jobs, we can create any number--for example, have people dig holes and then fill them up again or perform other useless tasks. Work is sometimes its own reward. Mostly, however, it is the price we pay to get the things we want. Our real objective is not just jobs but productive jobs--jobs that will mean more goods and services to consume.

Another fallacy seldom contradicted is that exports are good, imports bad. The truth is very different. We cannot eat, wear, or enjoy the goods we send abroad. We eat bananas from Central America, wear Italian shoes, drive German automobiles, and enjoy programs we see on our Japanese TV sets. Our gain from foreign trade is what we import. Exports are the price we pay to get imports. As Adam Smith saw so clearly, the citizens of a nation benefit from getting as large a volume of imports as possible in return for its exports or, equivalently, from exporting as little as possible to pay for its imports.

The misleading terminology we use reflects these erroneous ideas. "Protection" really means exploiting the consumer. A "favorable balance of trade" really means exporting more than we import, sending abroad goods of greater total value than the goods we get from abroad. In your private household, you would surely prefer to pay less for more rather than the other way around, yet that would be termed an "unfavorable balance of payments" in foreign trade.

The argument in favor of tariffs that has the greatest emotional appeal to the public at large is the alleged need to protect the high standard of living of American workers from the "unfair" competition of workers in Japan or Korea or Hong Kong who are willing to work for a much lower wage. What is wrong with this argument? Don't we want to protect the high standard of living of our people?

The fallacy in this argument is the loose use of the terms "high" wage and "low" wage. What do high and low wages mean? American workers are paid in dollars; Japanese workers are paid in yen. How do we compare wages in dollars with wages in yen? How many yen equal a dollar? What determines the exchange rate?

Consider an extreme case. Suppose that, to begin with, 360 yen equal a dollar. At this exchange rate, the actual rate of exchange for many years, suppose that the Japanese can produce and sell everything for fewer dollars than we can in the United States--TV sets, automobiles, steel, and even soybeans, wheat, milk, and ice cream. If we had free international trade, we would try to buy all our goods from Japan. This would seem to be the extreme horror story of the kind depicted by the defenders of tariffs--we would be flooded with Japanese goods and could sell them nothing.

Before throwing up your hands in horror, carry the analysis one step further. How would we pay the Japanese? We would offer them dollar bills. What would they do with the dollar bills? We have assumed that at 360 yen to the dollar everything is cheaper in Japan, so there is nothing in the U.S. market that they would want to buy. If the Japanese exporters were willing to burn or bury the dollar bills, that would be wonderful for us. We would get all kinds of goods for green pieces of paper that we can produce in great abundance and very cheaply. We would have the most marvelous export industry conceivable.

Of course, the Japanese would not in fact sell us useful goods in order to get useless pieces of paper to bury or burn. Like us, they want to get something real in return for their work. If all goods were cheaper in Japan than in the United States at 360 yen to the dollar, the exporters would try to get rid of their dollars, would try to sell them for 360 yen to the dollar in order to buy the cheaper Japanese goods. But who would be willing to buy the dollars? What is true for the Japanese exporter is true for everyone in Japan. No one will be willing to give 360 yen in exchange for one dollar if 360 yen will buy more of everything in Japan than one dollar will buy in the United States. The exporters, on discovering that no one will buy their dollars at 360 yen, will offer to take fewer yen for a dollar. The price of the dollar in terms of the yen will go down--to 300 yen for a dollar or 250 yen or 200 yen. Put the other way around, it will take more and more dollars to buy a given number of Japanese yen. Japanese goods are priced in yen, so their price in dollars will go up. Conversely, U.S. goods are priced in dollars, so the more dollars the Japanese get for a given number of yen, the cheaper U.S. goods become to the Japanese in terms of yen.

The price of the dollar in terms of yen would fall, until, on the average, the dollar value of goods that the Japanese buy from the United States roughly equaled the dollar value of goods that the United States buys from Japan. At that price everybody who wanted to buy yen for dollars would find someone who was willing to sell him yen for dollars.

The actual situation is, of course, more complicated than this hypothetical example. Many nations, and not merely the United States and Japan, are engaged in trade, and the trade often takes roundabout directions. The Japanese may spend some of the dollars they earn in Brazil, the Brazilians in turn may spend those dollars in Germany, the Germans in the United States, and so on in endless complexity. However, the principle is the same. People, in whatever country, want dollars primarily to buy useful items, not to hoard, and there can be no balance of payments problem so long as the price of the dollar in terms of the yen or the deutsche mark or the franc is determined in a free market by voluntary transactions.

Why then all the furor about the "weakness" of the dollar? Why the repeated foreign exchange crises? The proximate reason is because foreign exchange rates have not been determined in a free market. Government central banks have intervened on a grand scale in order to influence the price of their currencies. In the process they have lost vast sums of their citizens' money (for the United States, close to two billion dollars from 1973 to early 1979). Even more important, they have prevented this important set of prices from performing its proper function. They have not been able to prevent the basic underlying economic forces from ultimately having their effect on exchange rates but have been able to maintain artificial exchange rates for substantial intervals. The effect has been to prevent gradual adjustment to the underlying forces. Small disturbances have accumulated into large ones, and ultimately there has been a major foreign exchange "crisis."

In all the voluminous literature of the past several centuries on free trade and protectionism, only three arguments have ever been advanced in favor of tariffs that even in principle may have some validity.

First is the national security argument--the argument that a thriving domestic steel industry, for example, is needed for defense. Although that argument is more often a rationalization for particular tariffs than a valid reason for them, it cannot be denied that on occasion it might justify the maintenance of otherwise uneconomical productive facilities. To go beyond this statement of possibility and establish in a specific case that a tariff or other trade restriction is justified in order to promote national security, it would be necessary to compare the cost of achieving the specific security objective in alternative ways and establish at least a prima facie case that a tariff is the least costly way. Such cost comparisons are seldom made in practice.

We could say to the rest of the world: We cannot force you to be free. But we believe in freedom and we intend to practice it.

The second is the "infant industry" argument advanced, for example, by Alexander Hamilton in his Report on Manufactures. There is, it is said, a potential industry that, if once established and assisted during its growing pains, could compete on equal terms in the world market. A temporary tariff is said to be justified in order to shelter the potential industry in its infancy and enable it to grow to maturity, when it can stand on its own feet. Even if the industry could compete successfully once established, that does not of itself justify an initial tariff. It is worthwhile for consumers to subsidize the industry initially--which is what they in effect do by levying a tariff--only if they will subsequently get back at least that subsidy in some other way, through prices lower than the world price or through some other advantages of having the industry. But in that case is a subsidy needed? Will it then not pay the original entrants into the industry to suffer initial losses in the expectation of being able to recoup them later? After all, most firms experience losses in their early years, when they are getting established. That is true if they enter a new industry or if they enter an existing one. Perhaps there may be some special reason why the original entrants cannot recoup their initial losses even though it may be worthwhile for the community at large to make the initial investment. But surely the presumption is the other way.

The infant industry argument is a smoke screen. The so-called infants never grow up. Once imposed, tariffs are seldom eliminated. Moreover, the argument is seldom used on behalf of true unborn infants that might conceivably be born and survive if given temporary protection; they have no spokesmen. It is used to justify tariffs for rather aged infants that can mount political pressure.

The third argument for tariffs that cannot be dismissed out of hand is the "beggar-thy-neighbor" argument. A country that is a major producer of a product, or that can join with a small number of other producers that together control a major share of production, may be able to take advantage of its monopoly position by raising the price of the product (the Organization of Petroleum Exporting Countries cartel is the obvious example). Instead of raising the price directly, the country can do so indirectly by imposing an export tax on the product--an export tariff. The benefit to itself will be less than the cost to others, but from the national point of view, there can be a gain. Similarly, a country that is the primary purchaser of a product--in economic jargon, has monopsony power--may be able to benefit by driving a hard bargain with the sellers and imposing an unduly low price on them. One way to do so is to impose a tariff on the import of the product. The net return to the seller is the price less the tariff, which is why this can be equivalent to buying at a lower price. In effect, the tariff is paid by the foreigners (we can think of no actual example). In practice this nationalistic approach is highly likely to promote retaliation by other countries. In addition, as for the infant industry argument, the actual political pressures tend to produce tariff structures that do not in fact take advantage of any monopoly or monopsony positions.

A fourth argument, one that was made by Alexander Hamilton and continues to be repeated down to the present, is that free trade would be fine if all other countries practiced free trade but that, so long as they do not, the United States cannot afford to. This argument has no validity whatsoever, either in principle or in practice. Other countries that impose restrictions on international trade do hurt us. But they also hurt themselves. Aside from the three cases just considered, if we impose restrictions in turn, we simply add to the harm to ourselves and also harm them as well. Competition in masochism and sadism is hardly a prescription for sensible international economic policy! Far from leading to a reduction in restrictions by other countries, this kind of retaliatory action simply leads to further restrictions.

We are a great nation, the leader of the world. It ill behooves us to require Hong Kong and Taiwan to impose export quotas on textiles to "protect" our textile industry at the expense of U.S. consumers and of Chinese workers in Hong Kong and Taiwan. We speak glowingly of the virtues of free trade, while we use our political and economic power to induce Japan to restrict exports of steel and TV sets. We should move unilaterally to free trade, not instantaneously but over a period of, say, five years, at a pace announced in advance.

Few measures that we could take would do more to promote the cause of freedom at home and abroad than complete free trade. Instead of making grants to foreign governments in the name of economic aid--thereby promoting socialism--while at the same time imposing restrictions on the products they produce--thereby hindering free enterprise--we could assume a consistent and principled stance. We could say to the rest of the world: We believe in freedom and intend to practice it. We cannot force you to be free. But we can offer full cooperation on equal terms to all. Our market is open to you without tariffs or other restrictions. Sell here what you can and wish to. Buy whatever you can and wish to. In that way cooperation among individuals can be worldwide and free.

-------------------------------------------------------------------------------- Adapted from "The Tyranny of Controls" in Free to Choose: A Personal Statement, by Milton Friedman and Rose Friedman, published by Harcourt Brace Jovanovich, © 1980. To order, call 800-543-1918. Available from the Hoover Press is The Essence of Friedman, edited by Kurt R. Leube. To order, call 800-935-2882. -------------------------------------------------------------------------------- Milton Friedman is a senior research fellow at the Hoover Institution. He was awarded the Nobel Prize in economic sciences in 1976. Rose Friedman studied economics as a graduate student at the University of Chicago and has collaborated with Milton Friedman on several books.

Lou Dobbs Transcript from CNNfn:

KITTY PILGRIM, CNN BUSINESS CORRESPONDENTS (voice-over): Crate after crate, aisle after aisle, Chinese goods. The U.S.-China Economic and Security Review Commission says that is a problem.

RICHARD D'AMATO, VICE CHAIRMAN, U.S.-CHINA COMMISSION: Chinese nonmarket and mercantilist trade practices have tilted the playing field unfairly against U.S. interests and need to be addressed by U.S. government more aggressively.

PILGRIM: U.S. imports from China outpace exports by more than 5 to 1, part of what the report calls the most lopsided trade relationship the United States has. The United States imports $152 billion worth of goods from China, but only exports $28 billion. The report finds that contributes to the erosion of U.S. manufacturing jobs, something critical to the nation's economic and national security.

JOHN TRACIK, HERITAGE FOUNDATION: The erosion of a manufacturing base to China is a problem for the United States because, frankly, a world superpower cannot survive as a superpower without an industrial base. It's just impossible.

PILGRIM: And the report recommended the U.S. Trade Representative Office should investigate China's system of government subsidies from manufacturing and address China's exchange manipulation.

In the broader context, some China experts think the U.S. relationship will be a difficult one.

KURT CAMPBELL, CENTER FOR STRATEGIC & INTERNATIONAL STUDIES: The idea that is underscored in this report is that it's possible to have a strong, stable relationship with China? I don't buy it. I think by its very nature, U.S.-Chinese relations are going to be complex and contradictory for years, perhaps decades, to come.

PILGRIM: On the issues of security, the report finds some disturbing trends. China is buying time by reassuring its neighbors of long-term peaceful intentions. Meanwhile, it's strengthening its military. And the report questions China's commitment to a peaceful approach to Taiwan or preserving Hong Kong's autonomy.

(END VIDEOTAPE)

PILGRIM: Now China is important for its role in brokering talks with North Korea, and that, says the report, will be the true test of U.S.-China relations. But that role should not rule out investigating other practices the United States finds damaging to its economy or its national security -- Lou.

DOBBS: Remarkable. This report is simply remarkable on every aspect. Kitty, thank you.

Kitty Pilgrim.

I'm joined now by the chairman of the U.S.-China Economic and Security Review Commission, Roger Robinson, who joins us tonight from our Washington, D.C., bureau.

Good to have you here.

This report, as you undoubtedly realized as you were preparing it, is a blockbuster in terms of the direction of this administration's policy and the one before it, the Clinton administration?

ROGER ROBINSON, U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION: Well, Lou, we're mandated by the Congress to look at the downside risk in this very expansive and complex bilateral relationship, arguably the most complex of any this country faces.

The Congress is very engaged in matters concerning U.S.-China trade, both on the economic and the national security front. So it's not surprising that they would want a series of metrics or an ability to measure year to year where we are in that relationship.

Are we making significant progress, are we at a standstill, or is our situation actually deteriorating? And we found out to our chagrin that it was primarily the latter.

DOBBS: Roger, there are many people -- and,frankly, I would have to be very candid with you and tell you I'm amongst those -- who are not surprised by the findings on the trade deficit. China is engaging in managed trade, trying to achieve maximum surpluses wherever it possibly can.

Why, in your judgment, as you review these policies, has this administration in particular followed policies that resulted in almost $130 billion deficit last year with China and a deficit that's running 20 percent higher this year?

ROBINSON: If we look at the underpinnings of this massive trade deficit, which is, by the way, on track to setting a new record this year, we find a number of disturbing issues that haven't been adequately treated, in the view of the commission.

Obviously, the currency manipulation issue is right at the top of that list, some 15 percent to 40 percent undervalued in our estimation. A significant repegging to a basket of currencies is urgently required. We have an array of subsidies from capital to labor and others that have not been sufficiently treated, and we've been very reticent, as you know, to hold China's feet to the fire concerning its WTO commitments and bringing these issues to the settlement dispute mechanism. DOBBS: Not only has this administration -- and, again, in all fairness, the Clinton administration before -- been hesitant to bring about any sort of balanced trade approach to China. In point of fact, there's been a delinking of political and economic policy toward China.

Is it -- as you've assessed what is happening in this relationship with what is happening in Hong Kong and other issues of human rights within China mainland, is it a time to consider tying political interests -- U.S. political interests -- and commercial interests into a policy for China?

ROBINSON: Well, one thing you've mentioned, Lou, that I think I agree with and the commission would buy as well is this notion of being very careful about the undue and inappropriate linkage of national security foreign policy issues with the trade issues.

There are many that would argue that, for example, the administration -- and even previous administrations -- might have been willing to look the other way on unfair trade practices and competition in favor of bigger picture foreign policy and national security goals.

You know that the North Korean nuclear crisis is at the top of that list today. How much are we not holding Chinese feet to the fire in the effort to secure greater Chinese cooperation in the resolution of that crisis?

We think that these issues should be dealt with on their own merits, that we have for too long allowed this honeymoon and in effect debilitating circumstance to be able to be maintained.

DOBBS: And you and your commission have raised a critical issue in terms of the manufacturing base that has been lost specifically to China, and that is, of course, the importance of a solid, comprehensive manufacturing base to provide for the national security interests of this country. How alarming do you think the current situation is? What are the prospects of resolving it?

ROBINSON: Well, you know, since our commission was conceived in the year 2000, there have been overall some 2.8 million manufacturing jobs lost, some 17 percent of total manufacturing jobs. We're trying to explore, you know, what is China's level of responsibility for that massive erosion.

But you're quite right when you think of the manufacturing base as a fundamental national security issue of the United States. Economic security and national security are inextricably linked. I think we've learned that for some time now, and it's certainly the new reality of the 21st Century.

So we are now at -- in a circumstance where we have to take very seriously the idea that unfair trade practices are contributing in such a material way to that erosion and take concrete steps to reverse the situation. We offer the Congress some 38 recommendations to do this, and we feel that Congress is very alert to the kind of presentations that the commission's making in this reporting cycle.

DOBBS: Roger Robinson, chairman of the U.S.-China Commission.

We thank you for being here.

But, in general, the protective system of our day is conservative, while the free trade system is destructive. It breaks up old nationalities and pushes the antagonism of the proletariat and the bourgeoisie to the extreme point. In a word, the free trade system hastens the social revolution. It is in this revolutionary sense alone, gentlemen, that I vote in favor of free trade.

Thankyou for posting this Willie. Here are exerpts from the Republican Party Founding Platform of 1896:

For the first time since the Civil War the American people have witnessed the calamitous consequences of full and unrestricted Democratic control of the Government. It has been a record of unparalleled incapacity, dishonor and disaster. In administrative management it has ruthlessly sacrificed indispensable revenue, entailed an unceasing deficit, eked out ordinary current expenses with borrowed money, piled up the public debt by $262,000,000 in time of peace, forced an adverse balance of trade, kept a perpetual menace hanging over the redemption fund, pawned American credit to alien syndicates, and reversed all the measures and results of successful Republican rule. In the broad effect of its policy it has precipitated panic, blighted industry and trade with prolonged depression, closed factories, reduced work and wages, halted enterprise and crippled American production, while stimulating foreign production for the American market. Every consideration of public safety and individual interest demands that the Government shall be rescued from the hands of those who have shown themselves incapable of conducting it without disaster at home and dishonor abroad, and shall be restored to the party which for thirty years administered it with unequaled success and prosperity. And in this connection we heartily endorse the wisdom, patriotism and the success of the Administration of President Harrison.

Allegiance to Protection Renewed.

We renew and emphasize our allegiance to the policy of Protection as the bulwark of American industrial independence and the foundation of American development and prosperity. This true American policy taxes foreign products and encourages home industry; it puts the burden of revenue on foreign goods; it secures the American market for the American producer; it upholds the American standard of wages for the American workingman; it puts the factory by the side of the farm, and makes the American farmer less dependent on foreign demand and prices; it diffuses general thrift and founds the strength of all on the strength of each. In its reasonable application it is just, far and impartial, equally opposed to foreign control and domestic monopoly, to sectional discrimination and individual favoritism. [Emphasis mine]

We denounce the present Democratic tariff as sectional, injurious to the public credit and destructive to business enterprise. We demand such an equitable tariff on foreign imports which come into competition with American products, as will not only furnish adequate revenue for the necessary expenses of the Government, but will protect American labor from degradation to the wage level of other lands. We are not pledged to any particular schedules. The question of rates is a practical question, to be governed by the conditions of the time and of production; the ruling and uncompromising principle is the protection and development of American labor and industry. The country demands a right settlement, and then it wants rest.

Reciprocity Demanded.

We believe the repeal of the reciprocity arrangements negotiated by the last Republican Administration was a national calamity, and we demand their renewal and extension on such terms as will equalize our trade with other nations, remove the restrictions which now obstruct the sale of American products in the ports of other countries, and secure enlarged markets for the products of our farms, forests and factories. Protection and reciprocity are twin measures of Republican policy and go hand in hand. Democratic rule has recklessly struck down both, and both must be re-established. Protection for what we produce; free admission for the necessaries of life which we do not produce; reciprocal agreements of mutual interest which gain open markets for us in return for our open market to others. Protection builds up domestic industry and trade and secures our own market for ourselves; reciprocity builds up foreign trade and finds an outlet for our surplus. We condemn the present Administration for not keeping faith with the sugar producers of this country; the Republican party favors such protection as will lead to the production on American soil of all the sugar which the American people use and for which they pay other countries more than $100,000,000 annually. To all our products--to those of the mine and the field, as well as those of the shop and the factory--to hemp, to wool, the product of the great industry of sheep husbandry, as well as to the finished woolens of the mill-- we promise the most ample protection.

Merchant Marine.
We favor restoring the early American policy of discriminating duties for the up building of our merchant marine and the protection of our shipping in the foreign carrying trade, so that American ships--the product of American labor, employed in American shipyards, sailing under the Stars and Stripes, and manned, officered and owned by Americans--can regain the carrying of our foreign commerce.

Foreign Immigration.

For the protection of the equality of our American citizenship and of the wages of our workingmen against the fatal competition of low-priced labor , we demand that the immigration laws be thoroughly enforced and so extended as to exclude from entrance to the United States those who can neither read nor write.

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