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.

When we tax corporations, those costs are either passed on to (1) the consumer, or (2) the shareholder--ALWAYS!

Don't forget the employees, whose paychecks are necessarily smaller, and the pensioners whose retirement is less secure when the government bleeds their employers white.

You'd think those great friends of the working man in the Democratic Party would have figured this out, but . . .

-ccm

Free Trade is an ideal that rarely exists in practice. It's basically the ability to trade with another party--to voluntarily enter into an exchange or transaction where goods, services, or capital changes hands, and where both parties feel they have benefited--with no governmental interference whatsoever. Those last 5 words are the rub. Taxes, tariffs, some treaty provisions, are all examples of governmental interference.

So does truly "free" trade exist anywhere in the world? Sure, on a very micro level. My daughter exchanges her labor--putting away dishes, folding clothes--for my capital, that is, her allowance. No taxes. No governmental dictums. Both parties benefit. Once you get too far beyond this micro level, "free" trade starts to get very blurry.

Here is UNESCO’s definition (and caveats):

In very simple terms, free trade can be defined as the absence of tariffs and import quotas on goods. This definition is based on the notion that the market is the best device to ensure consumers can access good products at the best price, and increase global wealth. The final goal of eliminating tariff barriers and national protection mechanisms is to allow the market to operate with no constraints. However, this approach to free trade takes no account of the fact that not all-trading partners are equal, and neither all products and services. Therefore, in an integrated global economy the conventional definition of free trade will no longer do, as trade in services is surging dramatically and new barriers are replacing conventional barriers such as tariff and import quotas.

There are three categories of obstacles to international trade:

* Tariff barriers (e.g. fiscal measures such as the imposition of custom duties)

* Non-tariff measures (e.g. legal and practice barriers such as screen quotas)

* Investment barriers (e.g. restriction or limitation of foreign capital or equity participation, control of the nationality of company directors, or restriction on the repatriation of capital).

with no governmental interference whatsoever

I haven't gotten through that whole post yet but I will come back in the morning.

As for that part, I do not actually believe in that statement. I do not agree with that definition of Free Trade. It is NOT an absence of rules or government interaction.

What a Free Trade Agreement actually is to have an equal set of rules, not a trade anarchy. In that case both governments are needed to uphold the law. Which is one law, which is an equal law for all parties. Free Trade is not the absence of rules and laws.

Well, I guess my definition of free trade falls into the Milton Friedman Definition of the term. True "Free Trade" is the unrestricted movement of capital, goods, and even labor between sovereignties. Rarely in global history has there been true free trade; we only get degrees of it. Now, there's more to free trade than just tariffs and regulations; free trade must also be on a level playing field. As an example, US tax law is currently skewed to favor foreign imports over domestic producers (and foreign domestic markets over American exporters) through a grotesque corporate tax system, which is actually higher than most of Western Europe. We then give billions in subsidies to a few selected companies, making them soft and ripe to get pummeled by the competition.

While that is a good definition of free trade I don't think it gets to the heart of what free trade is about. In my opinion free trade is about realizing that one country can't do/make everything. If the US wanted to, I am sure that we could be a self sufficient nation. If that were the case g/s and products would become more expensive because everything would be extremely inefficient and multiple sectors would be fighting over very limited resources (land, human, natural, and so on) and in turn prices go up. So the government agrees to the NAFTA's, FTA's and the such because if there is a free flow of goods, resources, capital (though there isn't now) that on average resources would be used in a more efficient manner, prices would be lower, there would be more innovation and growth of markets.

The system isn't perfect but outsourcing is needed because once you start propping up failing industries, that can't compete, you raise the prices in every industry. This can be seen by using the steel tariffs that Bush put on imported steel. Sure he helped the steel industry but anything that was made with metal (cars, appliances, buildings, and so on) just got more expensive. I doubt that there was any net gain to the economy as a whole and in fact I bet the overall impact of the steel tariffs was negative. So to wrap up while the loss of manufacturing jobs, textile jobs, and the like is regrettable, it is better for the overall growth of the economy. While those individuals may not be able to get a job in the same industry at the same pay there are other non-skilled (and non-retail) jobs being created.

Whether you agree with it or not, the traditional definition of "Free Trade" is just that: trade without governmental intervention. Free Markets are markets that are free from government involvement. In this day and age, the reality is that free trade does not exist. Except for micro micro transactions and some black market dealings, almost all trade involves some form of government intervention--whether that be a sales tax, income tax, minimum-wage law, import duty, excise tax, capital gains tax, trade agreement, etc. Not that all of these things are bad; in fact, some can be quite helpful, when applied in the right way.

I know this is just semantics, but either the phrase "Free Trade" is meaningless and should be thrown out, because it truly does not exist, or ALL of us--conservatives, moderates and liberals--somehow have to come up with a new definition, which will probably be closer to your definition. Right now, pending a revision of our cultural dictionary, I believe what you are referring to still has to be called "Fair Trade." And I agree. That's what we should have and practice: Fair Trade.

The system isn't perfect but outsourcing is needed because once you start propping up failing industries, that can't compete, you raise the prices in every industry.

The reason that the industries are failing is because of free trade. For example textiles...you don't wear clothes any more? Obviously, slave labor can product clothes at a cheaper price; have you noticed that they are much worse quality??

This can be seen by using the steel tariffs that Bush put on imported steel. Sure he helped the steel industry but anything that was made with metal (cars, appliances, buildings, and so on) just got more expensive.

Oh sure...heard of the steel shortage here in this country? It has bankrupted some huge fabricators. Why? Because China is consuming huge amounts of steel to build factories, skyscrapers, etc. You don't think we need a steel industry? Pick up a history book, and see what happened after Pearl Harbor was bombed. Steel prices spiked recently because WE DON'T PRODUCE IT HERE ANYMORE in any great amount! Just like oil! Great to rely on your enemies for something so vital to national defense, is it not?

While those individuals may not be able to get a job in the same industry at the same pay there are other non-skilled (and non-retail) jobs being created.

No there aren't. There are service jobs, including things like Nurse's Aid. The less-skilled health care field workers are going to be in huge demand with the aging baby boomers. The question for you is: Do you really want someone who used to make "widgets" (a job he/she chose because they probably aren't of the highest intelligence level or social skills) caring for Grandma in the home? I don't. I want people who CHOSE that job, not had to take it.

Ya know I've lived long enough to see the slide of this great country into third world status. We're not there just yet but the standard of living in this country as measured by an ordinary person has dropped dramtically.

Case in point: I remember when going to the dentist meant a rather relaxed uncrowded hour or so. Today it has become a socialist clinic with mostly foreign born workers who don't necessarily understand much English. Everyone is rushed and slap dash as my Dad used to say. BTW my dad was a GP who made house calls back in the 50's. He had poor patients and millionaires. The ones who could pay made up for the ones who couldn't. That's how he put it.

Sure this is anecdotal but that's what real life is like. The truth is that we are being encouraged to accept a lower standard of living, and I'm not talking about buying power alone. Little things like popular music have slipped out of the realm of decency. Back in the 20's,30's,40's, 50's and 60's popular tunes were part of the glue of American Culture. They were evident everywhere. Now they are only evidence of the decline of our culture into self absorbed indecency.

I don't have fancy charts and theories to throw around, just the experience of more than half a century and some of the wisdom that came to me from my father who was born in the Victorian Era. I grew up in a time when women knew they might have to work but that it would be better if they didn't. But don't get me started about that!

When all is said and done we will realize that we have sold out our freedom to the Chinese and the Russians for a new pair of sneakers.

I was posting in the middle of the night and I left out one word in my haste.

It should read like follows:

As for that part, I do not actually believe in that statement. I do not agree with that definition of Free Trade Agreements. It is NOT an absence of rules or government interaction.

FTAs do not take out all government interference. They seek to remove barriers and employ positive government assistance, thus creating a positive business environment. What they do do, is limit barriers and help promote trade. If we sign a deal, lets say with Singapore, that gives us distribution rights there. Lets say it gives us equal protection of property rights. Lets say it also gives us equal protection under the law. If someone doesn't pay, we have protection.

The previous barriers to entry were a lack of protection for our product and company and the legal framework to do business. That was a whole set of non tarriff barriers removed by employing government to help erase them.

They made the rules as minimal as possible with that particular partner. In many ways they have proverbally 'made their MAC compatible with our PC'.

FTAs often eliminate direct tarriffs too. Why go about encouraging trade then leave a big tarriff in place? The notion behond a FTA is to show favoritism because one has shown reciprocity.

Again, an FTA is government(s) issuing a and abiding by a fair set of rules, and where possible, getting out of the way. While its a drastic reduction in government intervention, it does not eliminate all government intervention.

Much of the government intervention is positive intervention.

Whether you agree with it or not, the traditional definition of "Free Trade" is just that: trade without governmental intervention.

Thats just the point. That is not the definition of it. It might be in some philosophical circles, but beyond that...

See post #57.

Even there, from state to state, its not an absence of government interference.

True there are no tarriffs, but what really defines it is equal protection under the law thus creating and maintaining a true market driven economy.

If there were no government intervention Microsoft would have never been sued, Standard Oil wouldn't have been broken up, and the telephone company wouldn't have been chopped into pieces.

The game doesn't start and stop with a discussion on tarriffs. Free Trade in its true form is a combination of many things. In fact, there are many things that we import right now from various countries that have zero tarriffs on them at our ports. Yet its not at all a Free Trade Agreement.

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