Reassessing America's Free Trade Policies

A little more than a month ago, Patrick J. Buchanan won an upset victory in the New Hampshire primary, running on a message of economic nationalism and renewed protectionism. While in recent weeks Buchanan's candidacy has faded, the success of his message has produced a new debate over the costs and benefits of free trade. Sadly, most of the Republican establishment has dismissed Buchanan's views as economic nonsense without realizing that his criticisms of current trade policy do have some basis in fact. Certainly, full-blown protectionism would inflict great harm on the American economy. But that does not necessarily imply that free trade is the answer. Rather, the United States should discard the obsolete notion that free trade is the best alternative in every case and instead selectively engage in protectionist practices both to force other nations to lower their own trade barriers and to benefit U.S. companies competing in imperfect markets.

Such policies necessarily run counter to the traditional view of free trade. Under this view, free trade benefits the whole world by allowing each nation to specialize in the goods it is most efficient at producing. Such a policy, of course, increases world efficiency and raises living standards to varying degrees throughout the world. No one can seriously dispute the existence of such gains from trade. What can be disputed is the belief espoused by many free traders that the United States benefits from having open borders regardless of the behavior of its trading partners.

According to this belief, if these partners keep their markets closed to our goods, they would only hurt themselves by forcing their consumers to pay higher prices for domestically--produced goods. Similarly, if our trading partners subsidize their companies to allow them to dump goods on U.S. markets by selling them at below cost, American consumers should accept such a gift even if U.S. producers are driven out of business by such unfair competition. In essence, the U.S. should embark on a free trade policy no matter what the circumstances.

Yet these implications of traditional trade theory simply do not hold true in the real world. It does matter if a nation maintains protectionist barriers against U.S. goods because such barriers hurt the U.S. economy. Admittedly, such trade barriers do not affect the trade balance, as free traders point out, because international flows of capital determine the trade balance and trade barriers do not affect such flows. However, trade barriers do hurt the American economy by denying it the benefits of producing for and competing in an additional market. In particular, such barriers, by limiting the number of goods individual U.S. industries can produce, hamper the efforts of American companies to achieve economies of scale the greater efficiency achieved by producing a large amount of a certain product.

This lost efficiency directly translates into lower productivity and hence lower living standards. Similarly, by denying U.S. companies access to markets, trade barriers restrain competition between U.S. companies and their foreign rivals. This restraint of competition stifles innovation and also contributes to lower levels of productivity and standards of living. Clearly, foreign trade barriers, such as those employed by Japan, directly contribute to a lower U.S. standard of living and can no longer be tolerated.

The United States should move swiftly to retaliate against nations, suh as Japan that continue to keep their markets closed to U.S. goods. The goal of such retaliations should be to ensure free trade by forcing other countries to the bargaining table. Admittedly, this is easier said than done. But the United States remains by far the largest economic market in the world, a market that protectionist nations like Japan depend on to a far greater degree than the U.S. depends on their markets. For example, Japan currently sends 30 percent of its exports to the United States while we send only 11 percent of our exports there. At the same time, U.S. exports account for 24 percent of Japanese imports while Japanese exports account for only 19 percent of U.S. imports.

Moreover, the United States' economy remains far less dependent on international trade than that of virtually any other industrialized nation. Clearly, in any bargaining situation the United States has the greater leverage in comparison to our major trading partners. We can and should use such power to pry open the markets of other nations for our benefit and for the benefit of the world economy.

At the same time, the United States must take a more aggressive role in subsidizing U.S. companies that compete in industries with imperfect competition. Under imperfect competition, a few companies dominate the industry due to the existence of barriers to entry and can therefore influence the market price to varying degrees. As a result, the price of a product does not reflect its cost. Rather, the price equals the cost plus an additional profit called an economic rent. These rents accrue to the companies that dominate the industry and eventually end up in the hands of the owners. In terms of international trade, the existence of imperfect competition means that subsidizing American companies to compete abroad makes sense. Such subsidization would allow American companies to temporarily lose money by selling at below cost in a foreign market until all foreign companies go bankrupt.

The American companies could then assume control of the market and extract economic rents which would accrue to the American owners of these companies. The continued existence of barriers of entry would keep other companies from entering the market, and the United States would be free to extract economic rents indefinitely. As long as these rents outweigh the initial subsidy, the American economy benefits from such strategic trade policy.

While such a policy would do little to endear us to our trading partners, these nations already use such practices against American companies. For example, heavy European subsidies of Airbus have allowed that company to gain a hefty market share in an imperfectly competitive industry once totally dominated by American firms. A U.S. retaliation in the form of subsidies for Boeing would counteract such gains and even drive the nations that subsidize Airbus to the bargaining table, where an agreement eliminating subsidies could be worked out. This would benefit both sides in comparison to a policy where both sides subsidize their domestic producers.

Yet despite the logic favoring a policy of limited strategic trade, many in the Republican party remain reluctant to abandon free trade. In so doing, they threaten both the continued political viability of the party and the economic health of the nation. It is time for the Republican party to replace free trade with a more flexible trade policy that allows for constructive responses to areas where free trade does not represent the best alternative. The United States can not and should not continue to tolerate the mercantilistic policies of its trading partners that result in lower, living standards for the American people. Buchanan's policies may not provide the answer to America's trade problems. But they do point in the right direction.