All Commentary
Saturday, April 1, 2000

Free Trade and Flexible Markets

Only Flexible Economies Can Grow and Prosper

Christopher Mayer, a commercial loan officer, is studying for his MBA at the University of Maryland.

International trade plays a critical and often overlooked role in the prosperity of the world’s economy. Imprudence on the part of governments can stifle growth and trigger painful unnecessary contractions. The Smoot-Hawley tariff of 1930 was a major cause of the Great Depression. Punishing protective tariff rates precipitated an international trade war that caused U.S. farmers to lose a third of their markets. Agricultural prices plummeted as those farmers were caught with a supply that exceeded domestic demand. Their debts became a tremendous burden. Many farmers went bankrupt. The banks that lent these farmers the money soon followed them into bankruptcy. This started a credit contraction that rippled back east to the banks that had lent money to the midwestern banks.

The Smoot-Hawley tariff was perhaps the most protectionist piece of legislation ever adopted in this country’s history. While no such legislation currently appears on the horizon, that tariff should be a lesson for current policymakers, who seem to be forgetting the power of international trade. Witness the well-publicized and escalating trade war between the United States and the European Union, which originated over bananas and continues with the latest tussle occurring over beef. Since trade wars are really fought against oneself, all nations partaking in this nonsense are equally responsible and equally capable of ending the conflict by simply abandoning tariffs altogether. A tariff is, after all, a tax on domestic consumers.

Ominous Signs

Other evidence of an emerging trade war can be seen in smaller sectors of the economy, like making men’s suits. In “Is This How Tariffs Should Work?” Investor’s Business Daily outlined the loss of jobs in the domestic tailored-clothing industry. The workforce in this industry has been cut in half in just under a decade from 58,000 to 30,000. Why? Because the United States imposed punishing tariffs on imported fabrics, often exceeding 30 percent. Canada smartly dropped its tariffs on imported fabrics entirely, and its suit makers are thriving. They’ve increased their exports to the United States 250 percent.

Here the shortsightedness of protectionism is evident. In its effort to save jobs in the textile industry, the government harmed domestic producers and consumers. You would think such stark evidence, and the broad-based support for a reduction or elimination of the tariff from suit makers and retailers, would dispose of the matter. Wrong. Instead, there is talk of slapping a big tariff on imported suits.

As IBD notes, “That, of course, would be self-defeating. No one wins a trade war. They only make matters worse. When a country fires a shot (a tariff created or increased), the targeted country responds in kind.”

A futile, costly, and stupid policy once again seems to be the order of the day. The lessons of free trade need to be continually preached, because it’s clear that the policy-makers don’t get it.

They would do well to read Frederic Bastiat, who wrote, “Assume, if it amuses you, that foreigners flood our shores with all kinds of useful goods, without asking anything from us; even if our imports are infinite and our exports nothing, I defy you to prove to me that we should be the poorer for it.”

Unfortunately, protectionism is among the most durable of economic sophisms. The arguments never change. Yet the lesson of free trade is so easy to learn. It is so basic, so fundamental to the nature of exchange; “so clear, so obvious, so indisputable,” Ludwig von Mises wrote, “that its opponents were unable to advance any arguments against it that could not be immediately refuted as completely mistaken and absurd.”

Constant Change

In a living, breathing economy, change is perhaps the only constant. Individuals’ subjective valuations of goods and services, and of money itself, are like quicksilver. Market prices, therefore, adjust according to the demand for and the supply of a particular good. Prices also respond to the demand for and stock of money. An economy unable to adjust, to reconfigure labor and capital to yield the best results, is an economy likely to be highly unstable and fraught with persistent misallocation.

An example of the benefits of free trade and the virtues of economic flexibility is to be seen in Hickory, North Carolina. Certain traditional sectors of Hickory’s economy—namely, the furniture, textile, and chemical industries—have been shrinking for many months as cheaper importers beat out domestic producers for market share. But Hickory is booming, and unemployment is at a 30-year low.

Why? Because of new fiber-optic cable plants, medical centers, semiconductor plants, and satellite manufacturing companies. While some may credit state incentives and education, I see the market economy doing exactly what it should be doing. The south has lost thousands of jobs in traditional industries such as textiles, chemicals, and paper. Those jobs tend to pay low wages and require few skills. But the south could not compete with cheaper foreign labor in these areas. So the capital in these industries migrated to where it would be more efficiently employed and new industries have taken advantage of a relatively well-educated labor force.

What government did not do is revealing. If protectionist policies had been followed, these new industries would likely never have come into being, and Hickory, emblematic of economic conditions in the bulk of the south, would have been on the front page for less favorable reasons, like unemployment and stagnation. Tariff protection would have perhaps ensured a longer life for the south’s textile mills, but at what cost? Citizens would have been subsidizing textile mills and forgoing the benefits of cheaper textiles and the additional goods created by the new industries. These people would have been worse off. The new industries freely stand on their own merits in the competitive market.

Belief in markets requires some vision and faith. In a sense, what’s happening in Hickory is a microcosm of what is going on throughout the country. Our economy is constantly shifting to serve consumers better. Think of how this country has shifted from farming to heavy manufacturing to financial services and technology. And the changes will continue.

Japanese Woes

The trouble in Japan illustrates the same point but in a different way. While Hickory is booming, Japan is mired in a slump of historic proportions. Unemployment is the highest since statistics have been kept—despite Japan’s ingrained social pattern of lifetime employment. Or, more accurately, because of it. Japan’s tale is one of inflexibility and of trying to overlay a matrix of rigidity and stability on a changing complex market economy.

Despite major economic distress, Japanese companies are reluctant to cut workers. This has the effect of choking off the development of new industries and stifling the shifting of workers to where consumers would want them. Instead, they remained trapped in industries that bleed with losses. The difficulty in letting workers go has a flip side: Japanese companies are reluctant to hire new workers.

Flexibility means change and, for some people, a sense of uneasiness. It means that we are not likely to stay in one job for 20 years and that we will have to upgrade our job skills continuously. However, change is inherent in the real world. The societies that have the most flexible economies are equipped to handle their changing needs. They will grow, prosper, and change, while those anchored by political chains or societal bonds will go through periods of struggle and suffering.

  • Paul Milstein Professor of Real Estate at Columbia Business School, where he is also the Research Director of the Paul Milstein Center for Real Estate. In addition, he has also been a Visiting Scholar at the Federal Reserve Bank of New York, and Research Associate at the National Bureau of Economic Research.