The Difference Between Free Trade and New Trade

So one of the Chinese professors from Peking University got up and said “Developed countries, including the U.S.A. were once underdeveloped. Mercantilism allowed them to become developed. Now that they are developed they want to push free trade on the rest of the world” — Beijing Symposium on Trade. Tsinghua University — 2012)

Traditionally members of the Republican Party have been proponents of a Laissez-Faire approach to markets promoting unrestricted trade. Democrats on the other hand have been more interested in partnering with unions and labor in order to protect jobs.

However, the last two democratic presidents have been very willing to create free trade agreements those unions, labor and progressives within the Democratic Party have called damaging to the U.S. economy. At this point in time however, it seems that the U.S. is pretty much on board with promoting and practicing free trade on a grand scale.

Some economists laud the benefits of free trade. The main reason they give is that it is beneficial for a country to engage in international trade even when it buys products it is able to produce for itself. They claim that international trade allows a country to specialize in the manufacture and export of product it can produce efficiently. It can then import other products that can be produced more efficiently in other countries.

These economists claim that this process brings down prices at home, allowing consumers to spend more money in other products which is good for the economy. The middle class and the poor benefit as they are able to buy products not accessible to them at higher prices.

There are also geopolitical reasons for free trade, specially for entering into FTA’s or free trade agreements. Examples of this are the FTA’s formed with Israel and with Jordan. These agreements were obviously put in place in order to reaffirm American support and strengthen relations with these countries. One of the reasons for NAFTA was to integrate a Latin American country into the North American economy and to create a strong political partnership between the three countries.

The TPP or Trans-Pacific Partnership is another case where the U.S. tries to influence countries through the lure of access to the American markets. It is obvious that President Obama signed the agreement in order for the U.S. to reassert it’s influence in the Pacific Rim over increasing Chinese influence and pressure.

Globalization facilitates and seems to beckon free trade. The tendency of globalization is for businesses, technologies, or philosophies to spread throughout the world.

Whether your view of globalization is more in line with the social-cultural dimensions of globalization, or whether you are in line with industry that sees globalization as a business opportunity, the fact is that the world is interconnected in many different ways, and this interconnectedness is not going away. In fact, it will increase in the future.

In the meantime, what do we do about free trade? Do we continue blindly trusting the Milton Friedmans of the world who claim that international trade should be totally free? These economists, politicians and business leaders want no import duties, no import quotas, no anti-dumping, or any other American-imposed restrictions on trade.

However there are other economists such as Dr. Paul Krugman and Dr. Kamal Monnoo (there are many more ) that don’t quite agree with this assertion.

Modern day thinking being that while expanding global markets is a worthy goal, history offers lessons that only fair and ‘constructive trade’ is what nations should be seeking — ‘constructive’ referring to a realization that only such trade is welcome that materially adds value to the home economy and ensures a gradual but clear development of its core national industries. (Dr Kamal Monnoo — March 2016)

Could a rich country be worse off with free trade? The economist Paul Samuelson said that the dynamic gains from trade may not always be beneficial, saying that free trade may ultimately result in lower wages in the rich country. One of the many reasons being that the ability to offshore service jobs that were traditionally not internationally mobile could have the effect of a mass inward migration into the U.S., where wages would then fall.

This all leads to the question if not free trade, is there another option? Some politicians call it “smart trade”; in international trade parlance it’s called “New Trade”.

New Trade
New trade theory suggests that the ability of firms to gain economies of scale (unit cost reductions associated with a large scale output) can have important implications for international trade and for the local economy. New trade theorists argue that using protectionist measures to build up a huge industrial base in certain industries will then allow those sectors to dominate the world market.

This is particularly important for infant industries (new industries) which later can allow countries to begin a path to specialization and control over global segments. This model can create the national specialization-by-industry observed in the industrial world (movies in Hollywood, watches in Switzerland, etc.).

Some economists, such as Ha-Joon Chang, had argued that protectionist policies had facilitated the development of the Japanese auto industries in the 1950s, when quotas and regulations prevented import competition. Japanese consumers suffered in the short term by being unable to buy superior vehicles produced by the world market, but eventually gained by having a local industry that could out-compete their international rivals.

These economies of scale can outweigh the more traditional theory of comparative advantage. In essence if a country specializes in a particular industry then it may gain economies of scale in that industry allowing for global dominance. This is especially important for firms who have the advantage of being an early entrant as they can become a dominant firm in the market.

Based on the assertion above, we can say that new trade theory suggests that governments have a role to play in promoting new industries and supporting the growth of key industries through strategic planning and investment.
A tactical approach in the usage of tariffs, subsidies and laws that prevent corporations from outsourcing crucial technologies could be needed to achieve the goal of economies of scale locally. (T. Pettinger — 2013)

Some final thoughts.

Most people will probably agree that in today’s globalized market place, mercantilism / protectionism is not going to work. Technological advances, transportation, population growth and the desire for world peace and harmony will not accommodate a trade theory based on isolation and 16th century notions of exporting to colonies.

In any respect, whether the reader feels that Free Trade is the way to go, or whether a more strategic approach such as New Trade should be used, there is one thing that we ought to consider. We need to come up with ways to protect displaced employees and thereby mitigate the effects of “harm concentration” caused when American production is moved to other countries.

Some economists have proposed benefits for employees displaced due to outsourcing that last up to three years and which pay 80% of the employee’s previous salary.

If the employee is able to find employment during this period of time, but the new position’s salary is less than the previous wage, the “displacement” benefit should cover the difference. Benefits should also include training so that the displaced person can retool and be able to find employment in another industry. Some European countries have similar programs.

Whatever we do it is not going to happen overnight. Placing 35% tariffs on merchandise coming in from Mexico is not the answer. First of all, NAFTA is law, and dissolving it requires congressional approval. The corporations that outsourced their manufacturing to Mexico or any other country will most likely not be able to restart their factories in the U.S. all that quickly.

What about hitting China with a 40% duty as has been previously suggested? If we do, we will be facing a trade war in which nobody wins. Additionally, as in the case of Mexico, how do we bring those factories back?

Perhaps a policy change that helps infant industries and first entrants will do more in creating economies of scale in cutting edge industries that could give the U.S. dominance in those world segments.

If you liked this article please hit recommend. My next topic will be on cross-cultural comparisons.

If you want to chat with me regarding international business, international marketing, international market development or export, let me know. I’ll be happy to help in any way that I can.

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