The "Fair" Trade Delusion

Wednesday, May 25, 2011

In the sprawling field of international relations, few debates are as persistent and acrimonious as the one between the advocates of "free trade" and "fair trade." The fair trade position takes the view that a wide range of tariffs, duties, and other conditions may be used to restrict the flow of goods and services across national or state boundaries. The free trade position, which I heartily endorse, holds that national trade policy should allow goods and services to move fluidly across national borders—just as if those borders did not exist. One way to achieve this end is to sign bilateral free trade accords with other nations, with an eye to reducing tariff barriers and other impediments to the free flow of goods and services.

Illustration by Barbara Kelley

Right now, the United States has three pending free trade agreements with South Korea, Colombia, and Panama. Signing them just as they are will expand growth and lead to more opportunities for all parties. Although the economics of free trade are straightforward, its politics are not.

Last week, that sometime friend of free trade, President Barack Obama, announced that he would not submit any of these three free trade agreements to Congress unless and until Congress decided to reauthorize and extend the Trade Adjustment Assistance ("TAA") program that offers a rich package of financial benefits to various workers whose jobs are lost as a result of imported goods and services.

The president’s political logic is depressingly clear. He is willing to hold hostage the large overall gains from free trade to his renewed demand for economic assistance to those individuals, often union members, who are dislocated by the onslaught of new goods and services into the United States. Those parties, like the Chamber of Commerce, which should know better, have supported the president with the pragmatic argument that it is better to yield on the TAA, and move forward on the mentioned free trade agreements, than to come away empty handed.

That pragmatic compromise will, however, strangle free trade. Once it is accepted that all free trade agreements can be tied to other demands, the sky is the limit. For instance, labor groups have long insisted on the fair trade provision that we can only have free trade agreements with those nations whose labor laws look remarkably like our own. Their intention is to use these conditions to hobble their foreign competitors by forcing the competitors to abandon their own low-cost practices, thereby depriving free trade of much of its punch. Environmental groups have also joined the fair trade fray by insisting that poorer countries must have public amenities that only rich countries can afford, so that they too become weakened competitors in the American market.

All of these clever maneuvers should be stoutly resisted as a matter of first principle. Quite simply, the label "fair trade" in the hands of its advocates is a snare and delusion. My objection to fair trade does not rest on the absurd proposition that "fairness" is irrelevant to market transactions. It is the broad definitions of both fair trade and "unfair competition" that turns them into the enemy of growth and competition properly understood.

Although the economics of free trade are straightforward, its politics are not.

What exactly is unfair competition? The differences between the narrow classical liberal definition and much broader progressive definition are too vivid to deny. To truly understand unfair competition, we should step back from international disputes over free trade and ask how the notion of unfair competition plays out in the context of domestic trade. Classical liberal theory does not dismiss "unfair competition" as an oxymoron. Quite the opposite, it develops a set of rules that isolate for attack cases where one competitor uses force and fraud to upset the balance in a competitive market.

Consider this example: well before the eighteenth century, a suit for unfair competition lay against one schoolmaster who fired shots across the path of students who were making their way to a rival school. As the students dispersed, the rival was allowed to sue his mischievous competitor even though he and his school were never in the line of fire. The point here is that no individual student could be expected to mount this costly effort against the aggressor—each student’s stake is too small. But the competitor who lost customers to force surely did care about the collapse of his business. Allowing such a suit advances social welfare by forcing people to compete solely on quality and price.

In modern times, the use of force continues to distort the operation of competitive markets. Every action by union workers to use or threaten force against non-union competitors involves exactly this kind of activity. Indeed, the entire law of labor picketing is so vexed precisely because it is often difficult to distinguish between picketers who seek merely to inform customers of a non-union shop so that they will no longer patronize it, and those who mix elements of coercion with those of persuasion.

A second form of unfair competition involves situations where one market participant uses fraud in order to win over the customers of his competitor. This fraud can operate in two ways. By the first, one competitor passes off his inferior goods as though they were the superior goods sold by a competitor, and thus seeks to profit from the reputation of a rival. By the second, one competitor falsely disparages the goods of a competitor in order to attract customers to his own goods. Both abusive forms of behavior should be stopped so that potential customers can make informed choices of the relevant value of the goods in question.

Unfair competition takes a far broader and more dangerous meaning in progressive theory, which reached its high point during the New Deal legislation of the 1930s. The 1935 National Labor Relations Act establishes a long list of "unfair labor practices" by employers against employees. One such practice includes the refusal to bargain in good faith with a labor union selected by workers in an election supervised by the National Labor Relations Board. Refusals to bargain under the classical liberal approach became problematic with firms that held a monopoly position in a given market, as was once commonly the case with common carriers. Intensely competitive labor markets don’t qualify for monopoly status, so the New Deal’s use of the term "unfair" flips the classical liberal approach on its head. Now the term unfair is used to entrench a labor monopoly, not to facilitate a return to competitive conditions.

In the hands of its advocates, the label "fair trade" is a snare and delusion.

Yet, there is nothing unfair in the refusal to bargain in a competitive market, which could not function if every employer were required to hire every worker that applied for a job. The key point here is that many people are surely harmed by their inability to get a job or, for that matter, to hire a worker. But within classical liberal theory, a sharp distinction has to be drawn between the harms attributable to competition and those to coercion.

To be sure, the person who loses a job worth $50,000 a year (competition) is far more upset than the individual whose $100 watch is stolen (coercion). But the right question to ask is not the size of the individual loss, but the effect that loss has on the overall social welfare. Stealing watches creates instability in property rights that leaves everyone worse off. Losing jobs in competitive markets usually leads to overall improvements in output from the more efficient deployment of resources.

In more technical terms, theft of property leads to negative sum games that are socially destructive. Competitive losses lead to positive sum games that are socially beneficial. The two should, therefore, receive totally different responses. We have learned that fundamental truth in domestic markets, for one of the U.S.’s crowning achievements under our constitutional scheme is its willingness to allow for the free movement of goods, services, and people across state lines.

So conduct this little thought experiment: what would be the state of play in the United States if every time a new firm opened up in one state it was required to fund trade assistance for workers at other firms who lost their jobs as a result? The need to compensate incumbent workers would drive out all new firms, and thus entrench inefficient firms in a near monopoly position. It is for that reason that the proper response is always to ignore these losses, and to deal with the question of unemployment through a generalized system of unemployment insurance that, of course, has massive difficulties of its own.

We have to take the same approach to international trade that we take to domestic trade: open markets.

We have to take the same approach to international trade that we take to domestic trade. Those individuals who lose their jobs to foreign competitors are no better off than those who lose them to domestic competitors. These people should receive the same level of assistance, no more and no less.

In this universe of free trade, compensation takes place in a system-wide fashion, as the increased opportunities for labor help all workers alike, including those who have no jobs at all, those who lose their jobs, and those who hope to advance by finding better jobs for themselves. What is so tragically short-sighted in the Obama administration is that it is willing to sacrifice these systematic gains in favor of a tax-driven subsidy program that reduces all possibilities of gains from trade across the boards.

Given the Obama administration’s logic about trade assistance, it is fair to ask whether he and his union supporters are prepared to offer trade adjustment assistance to those nameless individuals whose own job prospects have been rendered bleaker by the president’s refusal to put these bilateral trade agreements to an up or down vote.

His answer would, of course, be in the negative, but for the worst of all possible reasons. Politicians don’t respond to real losses suffered by diffuse individuals who find themselves unable to organize interest-group pressure on their behalf. But these people should not be forgotten in the shuffle to hand out political goodies to the president’s allies.

Instead of getting lost in these political diversions, we should keep our gaze firmly on this central truth: the larger the expanse of the market, the greater the competitive forces everywhere within the system. More product, higher wages, and greater growth are the predictable consequences of a system that lets capital and labor flow to the areas of their higher use. As overall unemployment rates remain stubbornly high, I am hard pressed to think of any counterargument to free trade that is inconsistent with this fundamental insight: free trade leads to economic growth.