Can U.s. Trade Stand Apart?

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If argument by celestial analogy could kill, protectionism would be dead. But, of course, bad ideas die hard. Nearly all of our politicians and business leaders claim to believe in open markets and free competition. Yet in 1985, according to The New York Times , protectionist measures that found “broad support” in Congress included bills to restrict the importation of telephones from Japan, cement from Mexico, lumber from Canada, wine from France and Italy, blouses from Indonesia, shirts from China, and shoes from Taiwan and South Korea.

Modern economists use graphs and equations to make the argument in favor of free trade, but no one has made the case more effectively than Adam Smith in The Wealth of Nations , with a ringing appeal to the common sense of his readers. “It is the maxim of every prudent master of a family,” Smith wrote, “never to attempt to make at home what it will cost him more to make than to buy.”

“What is prudence in the conduct of every private family,” he went on, “can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them. … The general industry of the country … will not thereby be diminished … but only left to find out the way in which it can be employed with the greatest advantage.”

When he considers the common belief that a nation cannot tolerate a “disadvantageous” balance of trade, Smith loses his cool. This doctrine would find no support, he fumes, “had not the interested sophistry of merchants and manufacturers confounded the common sense of mankind.” Trade favors both parties to the exchange, and it makes no sense to fret about an “unfavourable” balance.

Nonetheless the advocates of protectionism have three arguments that deserve serious consideration:

First, it is often suggested that “infant industries” need to be guarded until they have grown to the point where they can stand on their own feet. This argument might justify the protectionist measures passed in support of the American textile industry just after the War of 1812, for instance, and the protectionist measures passed by Japan when it was re- building its economy from scratch after World War II. It does not justify the retention of trade barriers by Japan today, nor does it justify current demands for protection on the part of a textile industry that ought to have outgrown infancy a century ago.

In short, the Smoot-Hawley Tariff Act of 1930 turned out to be exactly what the economists had predicted— a complete disaster.

Second, as even Adam Smith conceded, tariffs may be justified as retaliatory measures when it seems likely that they will “procure the repeal of the high duties or prohibitions complained of.” As the example of the Smoot-Hawley tariffs suggests, however, retaliation can be a slippery slope. We should not leap upon it too eagerly or presume that we’ll be able to stop our plunge whenever we choose.

Third, though virtually all economists agree on the theoretical advantages of free trade, some of them argue that these advantages cease to exist if trade is not perfectly free. “This argument has no validity whatsoever,” says Milton Friedman, the winner of the Nobel Prize for economics in 1976. Other countries that raise barriers to trade do hurt us. But “if we impose restrictions in turn, we simply add to the harm to ourselves and also harm them as well.”

On balance, I think that a strong presumption against protectionist legislation is justified. When we examine arguments about “unfair” foreign competition, too often we find that what is unfair is that foreign competitors are making products that Americans want to buy, usually because the products are more reliable than American products, cheaper, or both. One answer to the problem is to improve our own products; a second is to get out of markets where we can’t compete and to concentrate on markets where we can.

It is important to understand that the rise in America’s trade deficit is tied to recent macroeconomic policy—specifically, the tight monetary policy that the Federal Reserve initiated to check inflation late in 1979. Tight money drove up interest rates, and high interest rates attracted foreign capital, with the result that by late in 1984, the exchange value of the dollar had risen by almost 60 percent. The strong dollar made foreign imports comparatively cheap for Americans and made our exports comparatively expensive for foreigners.

There’s an interesting fact about the foreign capital that our high interest rates have attracted: it helps us to finance our budget deficit. Net foreign investment in the United States rose from a negligible amount several years ago to almost $100 billion in 1984. Without that foreign investment, we would have to come to grips with the fact that we’re spending hundreds of billions of dollars more on government programs than we’re raising in tax revenues.

Here, as in the case of noncompetitive domestic industries, our problems proceed from our own lack of discipline. Instead of making products that can compete in the marketplace, our manufacturers sulk and cry foul. Instead of living within our means, we cheerfully run up deficits of nearly $200 billion.

Getting tough on Japan won’t solve these problems: we need to get tough on ourselves. The current revival of protectionist sentiment may delight the ghosts of Mr. Smoot and Mr. Hawley, but the ghost of Frédéric Bastiat shakes with laughter, and the ghost of Adam Smith groans.