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Why free trade is failing

By Peter Morici
web posted April 2, 2007

No policy could better serve the common progress of humanity than genuine free trade, but support for open trade is evaporating among American voters and foreign governments the United States hopes to engage.

Free trade is a compelling idea. Let each nation do more of what it does best, and trade will raise national productivity and incomes. However, these benefits are not guaranteed if a few nations can cheat on the rules.

The World Trade Organization has greatly reduced tariffs, prohibits virtually all export subsidies, and regulates other national policies that could subvert the trade, such as industrial development incentives and discriminatory commercial regulations.

For these rules to optimize trade, productivity and incomes, exchange rates between currencies must reasonably reflect production costs. To buy Chinese television sets, Americans must be able to purchase yuan with dollars; however, an artificially strong dollar that overprices U.S. tractors and software in China will unravel the benefits of trade.

Exchange rates are established in currency markets, created by businesses trading through major financial institutions. Unfortunately, China and several other Asian governments have blatantly manipulated these markets, without a credible U.S. response and with ruinous consequences for workers in the United States and elsewhere.

The United States exports $1.5 trillion in goods and services, annually, and these finance a like amount of imports. This raises U.S. GDP by about $160 billion, because workers are about 10 percent more productive in export industries, like finance, than in import-competing industries, like apparel.

Unfortunately, U.S. imports exceed exports by another $800 billion, and workers released from making those products go into non trade-competing industries, such as retailing, where productivity is at least 50 percent lower. This slashes GDP by about $400 billion, wipes out the gains from trade and requires workers displaced by imports to accept lower wages.

The trade deficit creates an excess supply of dollars in international currency markets, as Americans offer more dollars to purchase foreign products than foreigners seek to buy U.S. products. Simple supply and demand should drive down the value of the dollar against the yuan and other currencies, make U.S. imports more expensive and exports cheaper, and reduce the trade deficit. However, Beijing subverts this process by printing and selling yuan for dollars in currency markets, keeping its currency and exports artificially cheap.

This creates subsidies on exports equal to 8 percent of China's GDP, and Beijing offers many other subsidies to exporters, such as tax rebates and no payback bank loans. Other Asian countries are impelled to follow similar policies, lest their exports lose competitiveness to Chinese products.

U.S. firms harmed by subsidized imports from Europe, Canada or Japan can obtain relief from the Commerce Department in the form of countervailing duties but the Bush Administration refuses to apply similar WTO-compliant measures to China.

Consequently, many U.S. workers are pushed from high paying jobs, not because they can't compete, but because their president is disinterested. The ripple effect through labor markets creates great anxiety among workers and an anti free-trade sentiment that helped elect many new members of Congress.

Latin American workers suffer too. For two decades, their governments have adopted more open trade policies, but they can't compete in the vital U.S. market in the face of the special treatment for China and other Asian mercantilists. Now, U.S. prescriptions for extending free trade policies encounter populist resistance in places like Brazil and Venezuela.

More broadly, the Bush Administration will not likely win a global package of trade reforms through the Doha Round of multilateral negotiations, because skeptics in Congress don't see benefits from extending a system that needlessly destroys so many good jobs, China and other Asian mercantilists are profiting too much from the status quo to offer reasonable concessions, and Latin American politicians are wholly disillusioned with American prescriptions. As always, the Europeans and Japanese shy from supporting U.S. intentions when an American President is wounded by his own bad judgment.

Quite simply, free trade is failing, because President Bush refuses to stand up to Chinese mercantilism. ESR

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.

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