Currently in Congress, they are debating free trade bill agreements with Colombia, Peru, South Korea and Panama. I think that most Americans support free trade, but do not really understand why it is a good idea. It is hard to go through an economics education and not support free trade so this week I want to make it clearer why free trade agreements are good for you and good for America. To do this I will explain how the free market works fundamentally.
Imagine if you will, that you are stranded on a desert island with a complete stranger named Bob. Both of you need to survive. Bob makes a spear and heads out into the water to fish. It quickly becomes clear that Bob is not a very good swimmer and is rather uncoordinated. Bob is a terrible fisherman. You take your turn and quickly figure out that you are a better fisherman. You find coconut trees, but you can’t climb them to get the coconuts so you throw rocks. It takes a long time to dislodge them by throwing rocks. Bob has little problem getting to the top and tosses the coconuts down. You are a better fisherman and Bob is a better climber.
If you work on your own, you are likely to have fish to eat, but few coconuts. Bob is likely to have lots of coconuts, but few fish. So you trade. Now you both have a balanced diet. However, this is not the only benefit of trade. Instead of wasting your time throwing rocks at coconuts, you can spend all your time on fishing. Bob can spend all of his time on coconuts. Now, because of trade, both have more to eat than if you tried to do everything on your own. This is specialization of labor.
Now imagine again that there are two primitive villages. One town has rocky soil, but lots of good grass; the other has good soil, but has a weed that can make animals sick. If they don’t trade the rocky village will have to try to grow crops in rocky fields, and the good soil village tries to raise livestock that gets sick. When they trade, each village prospers because they can specialize in what they have a natural advantage just like the island example. The specialization of labor lets both towns excel because they only do what they do best.
However, the transition to trade has a few short-term losers and this is where the criticism comes. The rocky village has a few farmers who will lose business in the trade deal, and the good soil village has a few ranchers who suffer. Thankfully, this problem is not permanent. Human beings are smart enough to figure out how to make a living and the lost jobs are actually good for the village. Because the two towns can now produce more food with fewer workers, the displaced can do jobs that did not exist before because they had to concentrate only on food production. They can dig wells; build sturdier homes, and all sorts of technological progress. Free trade is why humans were able to develop civilizations. Without it, we would all still be hunting mammoths and picking berries.
Today, free trade works the same way. Some countries are poor so they are better at making labor-intensive products like clothing. However, these same countries often have unreliable infrastructure (water, electricity, education, etc…) and poorly developed legal institutions so they are not as good at making high tech products as we are here. Every country has some kind of activity in which they excel. This is called a comparative advantage. It is not that we can’t make the same products that they make; it is that they can make them cheaper.
This helps explain why free trade is good for America, but it doesn’t answer why free trade is good for you and me.
The main benefit that we receive is lower prices. Because there is more competition, free trade lowers prices. We import the products and services they can perform cheaper and we export the products and services we can perform cheaper. If these four trade bills were enacted and lower the overall price level by 1% that means you and I get a 1% raise.
You probably hear complaints about America’s trade deficit and that this is bad for the economy. According to freetrade.org:
An examination of annual changes in the current account balance compared to economic growth since 1980 shows that a "worsening" deficit is typically associated with faster economic growth, and an "improving" deficit with slower growth.
You have probably also heard that free trade encourages outsourcing of jobs to other countries. Even the AFL-CIO, who is very against free trade and outsourcing and is apt to exaggerate, believes that:
According to most estimates, American workers have lost hundreds of thousands of white-collar jobs to outsourcing over the past few years.
Since 2002, the U.S. has created almost 8 million jobs and the unemployment rate has fallen from 5.8 to 4.6 in 2006. It doesn’t look like it is hurting us that much.
So remember: Free trade strengthens the economy and lowers prices. New free trade agreements can cost people jobs temporarily, but this simply avails them for more productive tasks elsewhere.
As always, tell me what you think.