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How Nations Grow Rich: The Case for Free Trade

Ever since the modern nation state emerged half a millennium ago, the question of how nations grow rich has been bound up with international trade. The battle line in the debate, from the time of the mercantilists and Adam Smith to the controversies today about GATT and NAFTA, has been whether nations grow rich by restricting free trade or by engaging in it.

Professor Melvyn Krauss’s new book, How Nations Grow Rich: The Case for Free Trade, won’t end the debate, but it does provide a readable and well-argued defense of free trade on just about every point of current contention. As an emeritus professor of economics at New York University and the author of previous books on protectionism, foreign aid, and NATO, Krauss brings a deft hand to the task. Throughout his latest book, the author illuminates everything he surveys with clear writing and sound economic thinking.

Krauss begins at the beginning, by explaining the nearly two-century-old theory of comparative advantage in layman’s language. The fundamental economic argument for free trade is that it allocates resources more efficiently by allowing people and nations to specialize in what they do best.

We don’t trade with people in other nations to create more jobs. We trade to make ourselves better off. “Free trade does not create jobs—it creates income by reallocating or transferring jobs from the lower productivity to the higher productivity sectors of the economy. The argument for free trade—at least in the standard theory—is an efficient allocation of resources argument. Such reallocation increases income by increasing the average productivity of the nation’s stock of productive resources,” Krauss writes.

After his opening footwork, Krauss delivers a roundhouse right to the Clinton administration for its “managed trade” philosophy, followed by a series of quick jabs against the false arguments for protection. Among them is the assertion that free trade is only valid if it is “fair trade.” “This argument—that equity demands the United States protect its producers when foreign countries protect theirs—has a certain appeal but is nonetheless fallacious. Free trade is fair trade to those whom it counts the most to be fair to—the domestic consumer,” he writes. Other protectionist “tricks” Krauss exposes are the infant-industry argument, the “cheap labor” fallacy, and anti-dumping laws.

One of the most insightful sections of the book is Krauss’s analysis of how the modern welfare state has corroded support for free trade. The tax bite and labor-market rigidity of the welfare state have created the high unemployment we see today in Western Europe, which in turn foments domestic pressure to curb imports in a misguided effort to save jobs. The welfare state’s web of environmental and labor regulations that burden domestic producers invites further protection against rival industries in less regulated, and typically poorer, countries. Adding to the protectionist pressure are domestic subsidies to farming and other sectors, which then demand protection to maintain artificially high prices.

Krauss doubts that the welfare state and free trade can co-exist indefinitely. “The dilemma posed by this development is clear. Because of its evolving protectionism, the growth of the welfare state now threatens the very specialization and interdependence that is the basis for Western prosperity in the first place. The manner in which the Western industrial states resolve this dilemma to a large extent will determine their continued prosperity,” he warns.

In the United States, the tension between domestic intervention and free trade can be seen in the effort to “export” our environmental regulations to other countries. Among the lobbying groups opposed to NAFTA and other trade initiatives are environmental groups who worry that competition with less developed nations will put downward pressure on U.S. environmental standards in a regulatory “race to the bottom.” To placate the eco-protectionists, the Clinton administration wants to make the “harmonization” of regulations a part of any new trade agreements. Krauss argues that free trade need not lead to a lowering of environmental standards, but rather to a specialization of standards, with the more regulated countries expanding their low-polluting industries and other, less regulated countries expanding production of goods that produce relatively more pollution.

In the final three chapters, Krauss examines the wreckage of America’s foreign aid programs, the demise of socialist planning, and the rise of regional trade agreements, including a critique of the European Union’s drive for a single currency.

My only real complaint about How Nations Grow Rich is that Krauss did not write more of it. To be specific, his text is overstuffed with extended quotations, from the daily press as well as academic sources. It’s fine to quote a few lines from Milton Friedman, as Krauss does to good effect in the section on anti-dumping laws. But the book would have been even more readable, and about 20 pages shorter, without the frequent quotes from the daily financial papers.

Even this complaint should be taken as a compliment to Melvyn Krauss. In How Nations Grow Rich, his own words are almost always sufficient to carry the argument in favor of the liberty to trade and invest with people beyond our borders.

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