Our Misplaced Faith in Free Trade

http://www.nytimes.com/2014/10/04/opinion/sunday/our-misplaced-faith-in-free-trade.html

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Trade is one of the few areas on which mainstream economists firmly agree: More is better. But as the Obama administration pursues two huge new trade deals — one with countries in the Asia-Pacific region, the other with the European Union — Americans are skeptical. Only 17 percent believe that more trade leads to higher wages, according to a Pew Research Center survey released last month. Just 20 percent think trade creates jobs; 50 percent say it destroys them.

The skeptics are on to something. Free trade creates winners and losers — and American workers have been among the losers. Free trade has been a major (but not the only) factor behind the erosion in wages and job security among American workers. It has created tremendous prosperity — but mostly for those at the top.

Little wonder, then, that Americans, in another Pew survey, last winter, ranked protecting jobs as the second-most-important goal for foreign policy, barely below protecting us from terrorism.

Many economists dismiss these attitudes as the griping of people on the losing end of globalization, but they would do better to look inward, at the flaws in their models and theories. Since the 1970s, economic orthodoxy has argued for low tariffs, free capital flows, elimination of industrial subsidies, deregulation of labor markets, balanced budgets and low inflation. This philosophy — later known as the Washington Consensus — was the basis of advice the International Monetary Fund and the World Bank gave to developing countries in return for financial help.

The irony is that during the Industrial Revolution, today’s rich countries — Britain, France and the United States — pursued the very opposite policies: high tariffs, government investment in industry, financial regulations and fixed values for currencies. Trade expanded, and capital flowed anyway.

World War II changed everything. Tariffs were seen as having exacerbated the Depression, and inadequate globalization as one cause of the two world wars. So, through the late 1970s, the United States and Europe cut tariffs, though currencies were fixed and capital was still highly controlled. Astonishing American prosperity in the three decades after 1945 led economists to overestimate the impact of free trade. In reality, high growth in those years resulted from many factors: pent-up demand from the war; the Marshall Plan; Cold War military spending; investments in universities, highways and scientific research; and falling oil prices.

Starting in the 1970s, however, under the influence of free-market enthusiasts like Milton Friedman, economists urged further removal of barriers to trade and capital flows, hoping to turn the world into one highly efficient market, unobstructed by government.

The results were often disastrous. The lowering of protective tariffs did not lead to rapid growth in Latin America, which stagnated in the 1980s.

Mr. Friedman’s acolytes also urged the reduction or elimination of capital controls — starting in the 1970s in the United States, and in the 1980s in Europe — along with lower tariffs. This, too, was ruinous. An exodus of short-term investments contributed to financial crises in East Asia, Russia, Argentina and Turkey in the mid-1990s, and to the collapse of the Long-Term Capital Management hedge fund in 1998 (a prelude to the 2008 crisis).

Though these mistakes were recognized, the World Trade Organization continued to push one-size-fits-all rules, premised more on ideology than experience, that hurt developing countries.

In 1995, it demanded that members substantially reduce subsidies for export industries. Imagine what would have happened if South Korea, Japan and Taiwan had had to follow this guidance; they became economic powerhouses in the 1960s and 1970s by nurturing their export sectors. (To join the W.T.O., in 2001, China was forced to slash industrial subsidies, but it resorted to currency manipulation to boost its export sector.)

Also that year, the W.T.O. adopted a rule obliging members to abide by rich nations’ patent laws. (Never mind that Americans stole technologies from Europe throughout the 1800s.) These laws typically enabled investors in rich countries to reap substantial rewards, while poor nations like India were forced to pay the same price for patented drugs as the rich West, because they were not allowed to make generic substitutes.

But the consensus was flawed. Even free-trade advocates now admit that American wages have been reduced as a result of outsourcing, the erosion of manufacturing and an ever-increasing reliance on imports. Middle-income countries, meanwhile, have been blocked from adopting policies that might make them world-class competitors. Nations that have ignored the nostrums of the Washington Consensus — China, India and Brazil — have grown rapidly and raised their standards of living. Improvements in poverty and inequality occurred in Latin America only in the 2000s, after the I.M.F. and the World Bank reduced their grip on those nations.

Expanding global markets is a worthy goal, but history offers lessons that can lead to more constructive trade, capital and currency policies.

The first is that gradual reform is more effective than a sudden turn to free markets, deregulation and privatization. Shock therapy in Russia was a failure, and nations from Argentina to Thailand paid a dear price for liberalizing capital markets too quickly. The historical models of sustained growth are clear: gradual development of core industries; economic diversification; improvements in literacy and education, especially for women; slow, deliberate opening of capital markets; and the protection of labor from abusive pay and working conditions.

A second lesson is that nations should be left space for experimentation. Some spend too much on social programs, others too little; some need transportation infrastructure, others improved banking; some require literacy programs, others advanced education; some need to subsidize emerging industries, others to privatize bloated state industries; some need worker protections like unemployment insurance, others need labor mobility. Most have too few regulations to protect the environment, finance and consumers.

A third lesson is that models of growth that depend indefinitely on exports are not sustainable. The large imbalances in trade between China and the United States distort economies. The same is true of Germany’s huge trade surpluses, which are based on a fixed euro and restrained domestic wages.

Finally — and this is especially true for rich nations — every free-trade agreement should come with a plan to strengthen the social safety net, through job training, help for displaced workers, and longer-term and higher unemployment benefits. Free-trade deals must also be accompanied by policies to stimulate growth through infrastructure investments, subsidies for clean energy and, perhaps, other industries, as well as loans to small businesses, and even wage subsidies.

Free trade has been a priority for the Obama administration, but Congress, wisely, has not given it “fast track” authority, as it gave Presidents Bill Clinton and George W. Bush, to negotiate new trade deals without its approval.

Any trans-Pacific agreement, its terms still a secret, should be discussed in the open with ample protection of worker rights and healthy debate over regulatory changes requested by developing countries or big business. A trade agreement with the European Union makes more sense, but the danger is that environmental, financial and product-safety regulations will be watered down to meet the demands of corporate interests.

Economists are correct that free trade need not be a zero-sum game. But the genuine gains in prosperity from free trade can be maximized, and broadly shared, only if the policy errors of the past 40 years are properly understood.

Jeff Madrick is a senior fellow at the Century Foundation and the author, most recently, of “Seven Bad Ideas: How Mainstream Economists Have Damaged America and the World.”