Defining Ideas

The Rise of American Protectionism

Monday, March 14, 2016

The wedge issue of the 2016 primary campaign is the rising hostility to free trade—and, specifically, to the Trans-Pacific Partnership. On the Republican side, establishment candidates like Jeb Bush, Scott Walker, and Marco Rubio have failed or fallen behind, while Donald Trump maintains a commanding lead going into Florida and Ohio thanks, in large part, to his protectionist rhetoric. On the Democratic side, Hillary Clinton has been veering leftward to fight off a determined challenge from Vermont’s democratic socialist Bernie Sanders, another unapologetic protectionist.

There are of course major difference between the insidious Trump and buffoonish Sanders. The former, for example, favors low taxes and the latter confiscatory ones. Still, the real selling point of each boils down to one issue: In the indecorous language of the pollster, Pat Caddell, Americans feel “they have been screwed” by free trade. Caddell writes as if this virulent falsehood is an undisputed fact. What is undisputed, however, is that Adam Smith’s defense of free trade is in retreat as protectionism becomes the common thread across the both political parties. It is as though the economic unwisdom of the 1930 Smoot-Hawley Tariff Act is back. The question is why protectionism is having a political moment.

One answer is that things have not gone well in the United States. Standards of living have been static at best, and people feel economically insecure. In this environment, it is easy to blame the obvious culprits, like the tide of imports and the systematic movement of American jobs overseas to locations where the regulatory environment is more favorable and where the cost of labor is cheaper.

But putting the story in this fashion conceals the key benefit of free trade. Free trade offers an uncompromising indictment of, and a powerful corrective for, America’s unsound economic policies. Private investors have been voting with their feet in response to such policies. Simply put, the reason that local businesses outsource from the United States is the same reason why foreign businesses are reluctant to expand operations here. Our regulatory and labor environment is hostile to economic growth and there are no signs of that abating anytime soon. The United States has slipped to eleventh place on the Heritage Organization’s 2016 Index of Economic Freedom. And it is not just because other nations have moved up. It is also because the steady decline in freedom and productivity inside the United States has continued apace. Ironically, the strong likelihood that the next American president will expand protectionist practices will only make matters worse: firms, both foreign and domestic, are more reluctant to invest in the United States, and the risk of a trade war by other countries such as Mexico is a live possibility, especially if Trump imposes high tariffs on automobiles made there for the American market.

The great advantage of a free trade policy is that it both reduces these political risks and makes it impossible to conceal these glaring structural defects from the world. And once they are recognized at home, free trade gives the federal government and the individual states strong incentives to clean up their act so that they can once again be attractive to foreign investment. There is, moreover, only one way for that cleanup to proceed. The United States must reduce the drag that its regulations impose on all businesses that operate within its borders, which means rooting out the various forms of monopoly power, like unions, that can only survive if protected by state law.

This point explains why the American labor movement has historically opposed free trade. The essence of unionism is, and always will be, the acquisition of monopoly power. There is no way for a union to obtain that monopoly power in the marketplace. It can only secure it through legislation. The first step in that process was the exemption of unions from the antitrust laws under Section 6 of the Clayton Act of 1914. The second major step was the legitimation of collective bargaining under the National Labor Relations Act of 1935, which gave the union the exclusive bargaining rights against the firm once it was successful in a union election. These major statutory benefits strengthened private sector unions and imposed inefficiencies on unionized firms. This, in turn, opened the field for new firms, like the Japanese automobile companies, to organize outside the union envelope. In response, labor’s strategy went one step further. It pushed hard on trade and tariff barriers to keep out foreign imports, and exerted political influence to encourage local zoning boards to exclude new businesses that do not use union labor. Add to these issues the aggressive rise of minimum wage laws and other mandates like Obamacare and family leave statutes, and you construct a regulatory fortress that defeats the corrective forces of free trade and renders the nation less economically resilient and productive than before.

It is easy to say that people are “screwed” by free trade if you only look at the stories of those individuals who lose their jobs. It is much more difficult to make that case after taking into account the simple but powerful truth that overall levels of profitability and wealth increase under free trade. The short-term relief that targeted groups get from protectionist measures mask the larger inefficiencies that slow down the rate of growth. Despite what the Democrats think, transfer programs are no substitute for growth. Indeed, the imposition of new taxes without return benefits on the firms taxed only depresses the rate of return on investment further, which will necessarily compound the problem.

There is, however, a powerful way to see that free trade in international markets is not the villain. It is to look at trade and the competition for business between states. This point was missed by Time’s trade writer Rana Foroohar. She starts off correctly by noting that globalization and free trade do increase global wealth and prosperity. But she then adds this unwise caveat: “But they have also increased the wealth divide within countries, in part because these forces created concentrated groups of economic losers in specific parts of our country,” including the Midwestern Rust Belt, which gave Trump and Sanders the opening to power themselves to their recent victories in Michigan.

On this last point, Foroohar’s narrative goes badly astray. The Rust Belt states have been hit hard because they have been badly governed. They lose much of their business to other states that are better governed. Just look at the internal migration of people and businesses across state lines within the United States—changes that cannot be attributed to the supposedly malevolent influence of foreign trade on domestic trade. It can, however, be attributed to differences in the business climate across the states. The careful study by the Small Business Enterprise Council reveals a marked difference between low-ranking states like California (50), New Jersey (49), and New York (45) and high-ranking ones like South Dakota (1), Nevada (2), and Texas (3). It is wrong to dismiss these key differences, and to think that the decline in badly governed states is but a foretaste of what will happen across the board if free trade is allowed to run its course. 

These population shifts matter. Before California turned leftward, it was a magnet that drew huge numbers of people from New York into its borders. Now, it is places like Texas that are experiencing population growth. States like Illinois, New Jersey, and New York, all of which are under fierce financial pressure, are also the victims of outward migration. When it comes to the loss of manufacturing jobs—a big symbolic issue for people like Trump and Sanders—it is states like Illinois, as the Illinois Policy Center reminds us, that consistently lose out to Indiana, Michigan, and Wisconsin, which have recently enacted right-to-work laws, and which have sharply lower workers’ compensation rates. Strong union pressures block intelligent internal reform as the economic bleeding continues.

At this point, it is necessary to clarify once again the economic case for competition: The interplay of market forces tends to lead to the most efficient allocation of scarce resources. The creation of a monopoly raises prices over marginal costs by blocking beneficial trades, reducing firm formation, and diminishing innovation. The forces of competition are relentless in that they let no individual keep a lock on their current economic position. But that is exactly as it should be. American agriculture has long suffered on the view that farmers are entitled to guaranteed prices for their crops no matter what the conditions of supply and demand may be. The imposition of rent control and rent stabilization in certain key real estate markets like New York City drives up the costs of housing, including for people from outside the city who have no voice in local politics. The parties whose rights are vested celebrate the stability that government regulation brings into their lives. But they blissfully ignore the higher rates of uncertainty that their actions place on others who have fewer market opportunities for housing and jobs now that the incumbents have sewn up their protected positions.

The great challenge in this area is to ask whether there is some way to cushion the blow when the various legal protections are no longer made available to groups that have come to rely on them. Some people argue that displaced workers should receive job training programs or cash payments to ease their transition. But the former never work, and there is sensible resistance to the latter. And we never engage in these programs for loss of jobs from one state to another. There is, indeed, a third way to deal with this problem, which is not to assume that low rates of growth are a fixed fact of nature when they need not be. The best protection for the displaced tenant and worker is an open economy that offers multiple options for new housing and new jobs. But that won’t happen so long as we have national, state, and local policies that are protectionist to the core.

There you have it. The great bipartisan tragedy of the 2016 election is that Trump and Sanders want to double-down on the failed policies that have brought us to our current impasse. So long as economic discourse is controlled by economic know-nothings, prospects for economic improvement will remain bleak.