Free Trade Doesn't Work: What Should Replace It and Why, 2011 Edition Paperback – February 17, 2011

I’m surprised at how receptive I became to this book (and author) as I read it. First of all, the author deserves credit for such heavy research in the area of free trade. Every stigma the author talks about when it comes to free trade seems to be overwhelmingly true. With that said, a book challenging free trade needs to be substantially developed both empirically and theoretically to be taken seriously. Mr. Fletcher is clearly an intellectual, so forget the tin-foil hat. The author is not attacking trade itself for its power to enhance productivity and well-being when combined with divisions of labor…he is pointing out that there are externalities and dynamics (often significant) beneath surface. He also presents evidence that free trade acts as a conduit which exacerbates problems caused by perverse time preferences in consumption and saving…thus making it unsustainable.

I must say I had no idea how many weird defenses of free-trade there were. The only ones that should matter are those based on economic efficiency and sustainability. Nearly all of the reasons out there not based on this were shot down quickly by the author. I have learned an extensive amount of trade concept from this book pertaining to comparative advantage, mercantilist policies, path dependency of economies, scale economies…etc. However, I have critical thoughts pertaining to certain discussions.

The author’s theoretical “thought experiment” involving two nations (an attempt to attack totally free trade by pure theory) is insufficient to prove the unsustainability because of perverse time preferences. The example he provides doesn’t even need two nations, just two different sets of people (in terms of consumption time preferences) within one nation and the exact same situation may occur (I understand that with two nations one government may have policies which effect consumer time preferences, but his point is to rule out the very theory of totally free trade…which rules out these policies). How can free trade be the source of the problem if issues regarding perverse time incentives can occur within a single nation-state (or even a city for that matter)? If I accept this, then to be consistent I must be against credit or asset sale of any kind. Basic mechanisms (prices, exchange rates, interest rates…etc., all of which help to manage consumer time preference when not manipulated by a governing body) are ignored in this thought experiment, thus I can’t accept it as a theoretical refutation.

Now, with that said, the author’s discussion of real world capital movements is much more powerful. Pragmatically, whatever mechanism allows a trade deficit to be sustained, be it reserve currency status or non-tariff trade manipulations by other countries, it does have to be funded in some way (accounting-wise). Whatever the most attractive conduit is for allowing it to continue (mortgage loans, financial assets…etc.) will more than likely experience a bubble in the absence of a sound currency. Since as the author points out, trade surpluses both private and public (sovereign wealth funds) by definition must be invested abroad, any country running a sustained deficit will be prone to this type of expansion by investment from abroad (further sustaining the deficit). The sustained trade deficit combined with free movement of capital will act as credit expansion in the country running the deficit. From that perspective, the author seems to be fully justified, though this is also solved if artificial inflation is removed. However, it must be noted that while inflows of foreign capital may keep credit cheap in aggregate, on an individual basis credit premiums will still be adjusted based on prior debt levels (acting as a mechanism to somewhat dampen the effect). Here, the author suggests that fixed exchange rates may act as the mechanism which forces consumption time preferences into balance. I can’t deny the effectiveness, though this concept is in some way poorly elaborated. Countries don’t trade, people do. A “free-market” doesn’t involve a government running a massive budget deficit and maintaining artificially low interest rates. A profligate government’s debt issues are what allow for an easy conduit for the surplus country’s savers to fund foreign consumption (crowding out other options like consumption or foreigners’ domestic investment), and low interest rates are also what spur the individual to consume. Without easy-to-buy government treasuries, the type of personalized loans which would be required to sustain an over-seas trade deficit as he describes doesn’t seem realistic. As debt levels build in the deficit country, while they will be poorer in the short-term, that investment from abroad will eventually turn to consumption. Once it does, the surplus country’s consumption will either drive prices up domestically (encouraging consumption aimed toward the deficit country) or will be directed toward the deficit country in the first place (beginning to correct the deficit). The further problem with attempting to fix the problem with tariffs (adjusting the consumption time preference) is that the policy is set against aggregates, which muddles the results based on the skew of the distribution of wealth as well as the skewed distribution of consumption time preference. No matter what arbitrary consumption time preference policy is set, it will artificially encourage mal-investment in one industry and under-investment in another…even if still balancing in aggregate to the desired target.

He claims that the money saved from importing cheaper products has no measurable benefit, not even in theory, but then fails to adequately address this point (except saying maybe this is true in the long run but it’s not clear). He brings it up again in his “dubious assumptions” portion and in the conclusion just to say that sometimes the benefits gained will be less than the benefits lost. This analysis is incomplete. The goal of the study of economics should be centered around how to allow the populace to enjoy the same or more products and services of increasing quality but for less and less labor hours worked. If a foreign country can produce a product cheaper even after transportation costs and corruption, then additional aggregate savings from free trade may go to support other demanded industries through additional consumption or to savings (destined for investment to expand industries or create new ones). In the short-term this will cause displacement, but in the long-term encourages wealth-creation as laborers shift to other industries (just another factor playing into Schumpeter-style creative destruction, which the author acknowledges). Wealth-creation tends to be multiplicative in effect…thus the process can’t be judged by the results of any single industry displacement, but by the evolution of quality and efficiency over much longer periods of time. In fact, by the author’s description, globalization would appear to share characteristics with the industrial revolution…each involves massive labor shifts which suppressed labor’s share of capital but also improvements in purchasing power from both innovation and specialization (beginning with Deng Xiaoping's "glorious to be rich" proclamation which began the cheap Chinese manufacturing labor).

I enjoyed the brief history of protectionism, but I felt I was receiving mixed signals. Several times in the book the author says that “mostly free trade” is good, but that 100% free trade is not (even saying that 99% free trade may be good in a footnote). However, the broad tone he takes in the history portion would have you believe that any free trade is a mistake. Further, the author frequently points to short-term movements in economic growth as it pertains to changes in trade policy. This exercise of viewing free-trade in isolation is obviously of limited use, especially during large recessions covering broad geographical areas.

He states that “…increased access to the ruthlessly competitive global marketplace benefits only nations whose industries have something to sell which foreign trade barriers are currently keeping out” (p. 153). It must be remembered that not all benefits are directly observed. While the ability to import a capital good cheaper (savings passed to consumer through competition) is directly observable, the fear of new, importable substitutes pressuring prices down is not. Not all free trade benefits come in the form of employment, and not all downsides of protectionism can be effectively measured (negative externalities associated with protectionism were given roughly a couple pages in the whole book).

The author’s discussion of “ladder externalities” must be addressed. The author appears to make two points here: he states that the free market does not help spread technological innovation to other industries as efficiently as can be done; and that free trade causes countries to specialize in industries which fail to allow for ladder externalities. The first portion is very similar to criticism from Marx, who stated that in a socialist society any technological innovation would immediately benefit the whole society as it is shared from industry to industry. Joseph Schumpeter, who the author himself talks about as understanding the benefits of disequilibrium in economic growth, provides strong refutation to this idea in his book “Can Capitalism Survive.” Nearly all companies, even small ones, will have at least a skeleton projection of all revenues and costs to help determine how to operate in the future (very intricate for large companies, often excel files with 30 or so tabs of assumptions). While uncertainty always exists, these projections provide a quantitative way to make decisions (anyone in corporate finance knows how to run a basic discounted cash flow model or do an NPV or IRR analysis). The benefit of the free market is that corporate finance is the primary guide to decision making. Even if a technology is improved upon, it doesn’t mean that the most efficient course of action involves every industry updating its equipment and facilities. If it were, it would be reflected in a discounted cash flow analysis and the decision would provide a positive net present value. In the type of dynamic economy which exists today, would the author have companies scrapping and rebuilding facilities annually? I think not. The 5-10 year horizon of venture firms is irrelevant, as those firms are least likely to be able to continually adjust operating equipment. Other firms may only project out the same length of time because of the heavy uncertainty involved, but that is not a disadvantage. If gains from an innovation are expected in 13 years, immediate implementation may actually be a poor decision, as new innovations in that time frame could be captured in the normal corporate finance decision making process. Having a system of industry in place which encourages innovation is a good idea on paper, but this is far too “macro” a view. What of the supply and demand for such goods and services actually present right now. Should every country simply subsidize or protect tech even if the global supply of tech now significantly exceeds global demand? I can see benefits for an individual jurisdiction applying such methods in isolation, but if the system is applied to the world as a whole then massive mal-investment seems built in to the system by definition (perhaps the author should have addressed Ricardo’s other major theory on the “capital fund” to overcome this problem). Not to mention, industrial policy is not the only funding mechanism for biotech and RnD companies, as there is a massive private equity and university grant (funded from endowment, not always government) market to invest in such industry. Thus, while the movement from perfect competition to monopolistic competition to oligopoly…etc. has many desirable characteristics as described by the author (again drawing from Schumpeter’s criticisms of neo-classicism…clearly the author is a fan), the premise on how to get there feels misrepresented if actual existing supply and demand for goods is ignored (in other words I’m skeptical of the merits of abandoning the market as a guide to resource allocation and just arbitrarily attempting to innovate for innovation’s sake. Free market innovation occurs every day, and the history lesson provided about government technology successes may ignore the past unseen potential outcomes of the free market because of the funnel of capital into state-sponsored vehicles).

The author points out multiple times that trade runs both ways (we must give something: either consumption goods, the sale of capital assets, or promissory notes i.e. debt), but only briefly touches on the idea from the opposite perspective. His tariff “fix” may improve the balance of trade in one sense, but it may also further exacerbate the export problem as less imports means less potential consumption power to buy domestic exports. This is also true for any exports which involve imported capital goods. He discusses balancing monopoly gains (from building up industries domestically using protectionism) with Ricardian costs, but that’s the whole problem…how can a government ever do this? Perhaps with the wisdom of a deity, but as the author points out monopoly gains and Ricardian costs are dynamic. How is a government full of momentum-based bureaucracies and politicians serving short terms going to accurately measure this dynamic change and make appropriate long-term decisions (while being heavily lobbied by interest groups). Not to mention while protectionism may be one way to create scale economies (though possibly destroying foreign scale economies) free-trade allows them to occur naturally as it opens access to far greater demand pools. The author attacks this idea saying that some scale economies may occur even if another country would be better, but this is a ridiculous argument. No doubt it may occur, but how can any government ever know this in advance and set policy accordingly?

All in all, while intrigued, I’m not sure what to think. There’s no question that the author has exposed the imperfections of free trade and shown that protectionism can and has been a strong growth driver (though at times, like during the political discussion at the end, he sounds like he wants protectionism just for the sake of protectionism). However, it’s still not clear to me that the strings of industry can be successfully puppeteered on a competitive global level for any extended period of time (thus I’m torn on the rather ingenious blanket tariff solution or any artificial solution outside of fixed exchange rates or freely floating exchange rates for that matter). The author supports it because he claims “good” industries would be first to return to the U.S. since those are the industries the U.S. is closest to being competitive in. This somewhat ignores the focus on dynamic change throughout the rest of the book. If this system of tariffs and industrial policy truly worked and helped countries grow faster, then soon enough “bad” industries may also be brought back as foreign wages converge with U.S. wages. Consumers could be left with pointlessly lower purchasing power in nearly all industries as foreign nations develop (as was Adam Smith’s observation during a time of sweeping mercantilism). I did appreciate the author’s examination of comparative advantage. The clearest breakdown of comparative advantage comes in the form of capital mobility. Since comparative advantage assumes each nation will use capital goods to produce something, it can’t deal with situations involving the free movement of capital…as nothing automatically takes the place of the removed capital, potentially resulting in long-term geographically concentrated labor displacement or underemployment. But comparative advantage is not the only reason for trade, and erecting a tariff to block two nations trading on true differences in productivity (or justified scale economies) would be caught in his blanket tariff net. In a world of inflated money supplies and fiscal debt driving consumption, the author may have a point regarding unsustainability. However, free trade’s manipulation seems in many ways a symptom of the problem, not the source.

I’ve made my career developing international trade-management systems for multinational companies in the USA, Canada, Europe, Asia, the Middle East, and Latin America. I understand the pros and cons of free trade, and therefore wanted to review this book on the basis of how I understand the issues. I’m reviewing the book in June 2017, five and a half years after it was published. Have author Ian Fletcher’s opinions been validated or refuted during the past five+ years of free trade? I believe they have been validated.

Free trade treaties are sold to the American public and our Congress on the basis of highly dubious promises that did not pan out. We were told that “Free trade will create millions of high-paying jobs for America’s workers. Why, of course, they will! Our workers are the most productive in the world. Free trade will open other countries’ markets to our products and put our people to work building products to export. It will raise our economic growth from 3.5% to 5% or better! It will prosper the entire world! Rah! Rah! Cis-boom-bah for Free trade!”

The free trade treaties are signed, and we come back a few years to find that:

1. No noticeable amount of jobs have been created in the USA by free trade. In fact, jobs have disappeared. Companies that used to employ Americans fired their American employees who already had well-paying jobs, moved their work to Mexico or China, and now import the product back into the USA. The factory towns of the USA, which were supposed to prosper with free trade, have become a blighted wasteland.

2. The USA exports LESS after free trade agreements are signed, because American companies close their USA factories and therefore produce nothing in the USA to export. This book was written in 2011. We export less to most countries today, in 2017, than we did five years ago.

3. The economy shrivels when free trade agreements are signed. We already had 3.5% economic growth BEFORE free trade with many countries was signed. Today our economic growth averages 1.8%. It has been cut in half AFTER free trade treaties were signed.

4. The propaganda about free trade benefiting American workers is reversed after free trade is signed. When Free Trade Mavens are hawking their their free agreements they portray American workers “as the most productive workers in the world. They DESERVE the right to make products to sell to the rest of the world.” Then when the American workers lose their jobs BECAUSE of free trade, the Free Trade Mavens blame the workers: “American workers are too lazy, stupid, and mal-educated to compete with the rest of the world. That’s why we had to fire those miserable slackers. Don’t blame us when our free trade promises turn out to be a pack of lies. Blame American workers. It’s THEIR fault!”

5. Free trade agreements are signed on the promise that “We are going to export high-value computers, electronics, and appliances.” After we sign free trade agreements we start IMPORTING those products, and the American factories that used to make them shut down and lay off their workers. Then the Free Trade Maven propaganda changes to: “We are going export corn, wheat, and tree nuts” --- low-tech commodity products that have so little value that we must subsidize their production with imported labor and tax subsidies. So instead of exporting high-value products built by American labor, we export turnips that have to be grown by importing Mexican and Guatemalan labor!

6. Nor do these exports of ag products ever amount to much. Most countries protect their domestic farmers. Even our Canadian neighbors do not permit American farm products to glut their market. They wrote a clause into the NAFTA treaty allowing them to restrict imports of many American ag products to 3% of their domestic market. Even supposedly beef-hungry China never bought a single ounce of American meat.

7. The only time American businesses ever oppose free trade is when the imported products would prevent them from robbing American consumers. Big Pharma spends billions of dollars lobbying Congress not to allow the importation of foreign-made medicines. Why would they want to let an American buy a pill made in Mexico, Canada, or Germany for 89 cents, when they can monopolize the market in the USA and sell it for $89,000 dollars?

8. The world economy is less stable than it has been at any time since WWII. Global wealth has declined with the replacement of millions of American jobs at $25 / hour with the $2 / hour labor pool of Mexico and China. Not only has the USA become blighted by poverty, but Mexicans are poorer than they were before NAFTA, because the jobs they had before NAFTA have been replaced by $2 / hour jobs in American-owned and Chinese-owned sweatshop. What little growth there is in the world economy is propped up by trillions of dollars of public debt issued by world governments who have no intention of ever repaying it.

Fletcher explains why free trade is still supported even though on a common-sense basis it is indefensible.

Big Business promotes free trade because it allows them to fire their higher-paid workers in the USA; replace them with peons in Mexico and China; use Mexico and China as bases to import products into the USA --- thereby inflating corporation profits by arbitraging a First World price list with Third World labor; and avoiding paying taxes on the profits earned in the USA by laundering the money through overseas tax havens like Ireland where the effective tax rate on corporate profits is zero. Big Business promotes the creation of unelected supra-national organizations like the WTO, GATT, NAFTA, International Monetary Fund, and TPP to shield them from compliance with the laws of any nation. Since Big Business controls the supranational organizations, they become accomplices to multinational corporation piracy.

Liberals also support free trade because it promotes the creation of supra-national, unelected governing bodies that use each nation’s tax dollars to impose liberal values that don’t represent the people’s interests. As CNN reports today: “[French President] Emmanuel Macron is getting in Donald Trump's face….he's already seized a role as a bastion of liberal global values, staring down both US President Donald Trump and Russian President Vladimir Putin, two of the biggest threats to the political consensus that has dominated Western politics for decades”

Liberals see Globalism as a sort of supra-national welfare state that transfers wealth out of the USA and into the pockets of Third World peoples whom Liberals believe have been oppressed by years of oppression from the USA and Europe. In their view globalism, is a means of transferring wealth from the American middle class to the Third World poor. And of course, Liberals staff these supra-national governments with bureaucrats who are paid a lot of money funded with tax dollars.

Conservatives have an ideological bent in seeing free trade as a way to destroy national governments. They think that free trade will enable big business and wealthy to relocate out of high-tax countries and into tax havens and therefore force their home countries to lower taxes. Conservatives also despise labor unions and therefore imagine that by relocating businesses overseas they are helping to exterminate the left-leaning working class. Many Liberals also despise the supposedly ignorant (and largely Conservative-voting) working class Whites and seek to wipe them out by destroying their livelihoods with imports.

Thus do Liberals and Conservatives support free trade for all the wrong reasons.

Ian Fletcher also makes it clear that the world’s economists are paid by big government and big business interests, so they conform to the free trade agendas of their employers in order to keep their meal tickets coming.

Fletcher points out that economists are ignorant of the free trade icons they revere. For example, Adam Smith never believed in free trade as a means of beating higher-paid workers in developed countries out of their jobs by shipping work to low-wage countries. David Ricardo, the father of “comparative advantage by free trade” advised the Portuguese and British governments to embrace free trade. He thereby launched both countries on a journey to economic oblivion.

Nor do any other countries other than the USA, Britain, Canada, and Australia practice free trade. Every other country protects its markets from imports of USA-made products. We run $347 billion trade deficits with China; $155 billion with the European Union; $65 billion with Japan; $63 billion with Mexico; $28 billion with South Korea, and so on down the line. Our exports to all of these countries is lower today than they were in 2011 when this book was written. We even sell less to Canada today than then. Few countries want to buy American-made products, while we have allowed our American companies to take their production overseas and dump it back into the USA.

Furthermore, once an industry leaves the USA, it never comes back. The knowledge and traditions of that industry (known as “intellectual capital”) are sold by our CEO’s to foreign businesses and their government partners for a pittance. The USA no longer innovates much of anything in electronics because we no longer have an electronics industry here to innovate. Likewise, the rapid loss of our motor vehicle, aviation, and computing industries, is destined to make us a larger version of Portugal, which only knows how to export olives, wine, and goat cheese. So far, have propped our economy up with $20 trillion of government debt. Once that is defaulted on, it will be finis for the USA as a world power. This is exactly what China wants, and the reason why it protects its economy from USA-made products, while we allow the Chinese to sabotage our economy with predatory imports and cyber warfare.

Ian Fletcher sums it up this way:

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All over America, other industries are quietly falling apart in similar ways. Losing positions in key technologies means that whatever brilliant innovations Americans may dream up in small start-up companies in future, large-scale commercialization of those innovations will increasingly take place abroad. A similar fate befell Great Britain, which invented such staples of the postwar era as radar, the jet passenger plane, and the CAT scanner, only to see huge industries based on each end up in the U.S.

ARROGANCE AND INCOHERENCE

The media sometimes tell us that America’s labor force is so much more skilled than other nations that free trade will cause us to cream off the best jobs in the global economy. The next minute, they tell us that our poor math skills and work ethic are the root of our economic problems and that we should only blame ourselves. These obviously can’t both be true.

Sometimes, we are told to stop being arrogant and face up to the fact that the world isn’t our oyster anymore and that Americans aren’t entitled to be richer than foreigners. Fair enough: we’re not entitled to any particular living standard. But we certainly are entitled to a government that seeks to defend our prosperity, if that’s what we elected it to do.

Signs that America’s trade policies are dangerously wrong are often reinterpreted as evidence that our economy is so strong that it can survive even these problems. For example, because we have survived a trade deficit which would have produced a currency collapse in any other nation, trade deficits must not matter. But that is like saying that because the strong constitution of a patient has enabled her to survive cancer, cancer isn’t a disease. If free trade is a cancer slowly eating at our economy, we need to know now—especially if it is a problem whose solutions have long lead times.
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My skepticism of free trade is confirmed. If the USA does not reverse destructive “free trade” policies --- which in practice means allowing other countries to wreck our economy with imports, while keeping our products out of their countries --- then the USA isn’t going to remain a major economy. We will revert to a sort of North American Russia that has atomic weapons, a bit of oil and corn, and not much else.

Well thought out, very readable book.
The basic tenants of free trade are addressed and destructed. The style of the book is to prepare you for debating with others by addressing the standard (false) arguments for free trade.
Convincing argument against free trade both from the historical point of view and the analytical.

Highly thought-provoking and informative. Very well argued and pointing out numerous flaws in America's naive free trade policies under several recent past presidents. Indirectly and 5 years ahead of time, it almost predicts the most recent presidential election outcome.

I've read many books on economics and trade, this is one of the top books I've read. Many status quo economist might not agree with all of his ideas, but Mr. Fletcher is much more realistic and his strategies can help America Grow again. I highly recommend this book to anyone who wants to have a solid understanding of alternative TRADING STRATEGIES than what we'll get from mainstream media. GREAT and INFORMATIVE READ.