Is free trade always the answer?

As Brexit talks continue, we answer the key questions on the free flow of goods

As concerns over Donald Trump’s import tariffs intensify and ministers renegotiate Britain’s trading relationship with Europe, the postwar consensus towards ever-closer economic cooperation between wealthy nations is being unpicked.

Why is trade good?

Economists argue about a lot of things, yet many would probably agree on the benefits of free trade, which generates wealth by allowing the free flow of goods across international borders, without taxes and other such barriers.

The argument runs that billions of people around the world have been lifted out of poverty by the combined power of capitalism and free trade. We are taught that the world’s most powerful nations spurred their advance by tearing down the castle walls of protectionism during the latter half of the 19th century – ending centuries of beggar-thy-neighbour economic nationalism – opening up new markets to boost the industrial revolution and drive forward the development of the middle class.

John Stuart Mill wrote that, once upon a time, the average patriot “wished all countries weak, poor and ill-governed, but his own: he now sees in their wealth and progress a direct source of wealth and progress to his own country”.

Two ideas remain central to the theory of international trade more than 200 years later.

In his seminal work The Wealth of Nations, Adam Smith taught countries to concentrate their efforts on producing and selling goods in which they have an “absolute advantage” over their trading partners. Cheaper labour costs give modern-day China an absolute advantage over most western nations for manufacturing. But what happens when a country has absolute advantage in multiple industries?

In the 19th century, David Ricardo took the idea further by arguing that one country might have a comparative advantage over the other. He said it was possible for England to produce more wine and cloth than Portugal. However, it would require greater effort in England, handing Portugal a comparative advantage.

Both theories teach nations to focus their time on making and selling goods in which they have an advantage over their rivals, for mutual benefit through free trade. Consumers will benefit from lower prices in both nations.

Classical economic theory does not, however, always work in practice, and the rules require all nations to sing from the same hymn sheet. Unfettered capitalism across borders still creates winners and losers, posing thorny social and political questions for policymakers where dry economic models cannot help.

There are thousands of ways nations can distort the playing field. The most extreme might be the use of military intervention, although far more common are subsidies for particular industries, tax, spending and the use of the legal system. Trump’s import tariffs are the most high-profile example.

briefing box 1

How do import tariffs work?

Tariffs are border taxes charged on foreign imports. Importers pay the charges at the point of entry to the customs agency of the country or economic bloc imposing them.

Rather than being used to raise revenue, they are imposed to increase the price of foreign goods in order to make domestic produce comparatively cheaper, with the aim of encouraging domestic production and protecting firms from global competition.

Economists mostly agree higher tariffs are counterproductive. While they can protect jobs, they also tend to raise the price of goods for consumers and stifle innovation that could benefit the economy.

Countries signed up to the World Trade Organisation agree to keep their tariffs within certain limits. Acting as the ultimate arbiter in international tariff disputes, the club numbers about 160 nations including the UK, US, Japan and Germany, representing 96% of world trade. China joined in 2001 in a major moment for world trade and Russia became the world’s last major economy to become a member, in 2012.

With the US the most powerful nation in the WTO and the driving force behind its creation in 1995, much of the organisation is hewn in the image of America. Trump, however, views membership as a “disaster”.

Besides using tariffs to protect domestic industries, countries often provide support to certain sectors through state subsidies, or impose quotas restricting the volume of goods imported from overseas. There are also non-tariff barriers; such as patent rules, health and safety regulations, labour and environmental standards, and rules of origin (for example, parmesan cheese can only come from northern Italy).

Non-tariff rules have forged countries’ domestic policies closer together in recent decades to enable greater levels of international trade. After all, we wouldn’t want to have higher car safety standards for foreign goods than our own. Herein lie many of the arguments about how Britain will arrange its trade with the EU or US after Brexit.

There are fears the US would push Britain to lower its food safety standards. That could allow the sale of chlorinated chicken. Meanwhile, Brexiters are concerned the UK adhering to EU rules could hinder trade deals with the rest of the world.

Do trade deficits matter?

Many economists would argue trade deficits are an irrelevance, although surpluses are often seen as economic virility symbols.

Persistent deficits require funding via international borrowing, which becomes harder if confidence in a country falls. There are other risks from reliance on imports over domestic production. National security is one: should a country sacrifice the ability to produce steel required for making tanks, for example. Trump is using national security legislation for much of his tariffs, although some observers argue he has done so because the law is harder for the US political system to block, delay or modify.

The other risk is that imports support jobs overseas, rather than at home. Jobs! Jobs! Jobs! was the president’s rallying cry ahead of his election. Workers in industries competing most with imports – typically in manufacturing – do tend to lose out, economists have found, while employment shifts towards sectors less exposed to trade.

Without smooth transitions for struggling industries, or the safety net of the welfare state – through jobseeker benefits, education and training – whole communities can be left bereft of work. Britain during the 1980s was a classic example, as the government of Margaret Thatcher chose to shut UK mines and import coal from South Africa and Argentina.

Briefing box 2

Is free trade always the answer?

Trade deals always create winners and losers. But while the choice is a matter for politics, these decisions often come amid an onslaught of lobbying from powerful vested interests. Some observers argue free trade deals are therefore often simply the result of rent-seeking by politically well-connected parties.

The failed Transatlantic Trade and Investment Partnership between the US and the EU is one recent example, where corporate interests including the US private health industry wanted to expand to new markets in Europe. The deal ultimately failed amid widespread public opposition.

There are fears trade deals benefit larger corporations already operating across international borders, rather than smaller firms. Domestic producers can be squeezed out by global rivals with huge economies of scale.

The argument could be best put by the political theorist Isaiah Berlin who noted “freedom for the pike is death for the minnows”.

However, international firms often support networks of smaller companies in their supply chains. Greater trade barriers can make it more difficult for multinationals to operate across borders, meaning they could relocate elsewhere where it is easier for them to do so – directly and indirectly affecting jobs and economic growth. After the gradual advance of globalisation in recent years, rapidly unpicking the progress may cause severe short-term pain.

Economists argue international competition stimulates greater innovation and productivity, while warning protectionism can hinder progress. The quantity and quality of Soviet cars and other eastern bloc goods serves as one example, while the poor reputation of cars made by the British motor industry during the 1970s might be another. Consumers have benefited as the quality of goods have improved and prices have fallen.

What next?

There are already signs Trump’s import tariffs and retaliatory measures are having an effect. Industrial surveys show manufacturers are suffering from higher costs of materials and longer delivery times in the US and the eurozone, while production is also slowing.

Harley-Davidson has said it will need to move production of motorcycles for European consumers outside the US after the EU carried through a threat to tax American motorbikes, following the imposition of steel tariffs by Washington. In the UK, Airbus and BMW have warned of lost jobs and withheld investment triggered by uncertainty over the UK’s future trading relationship with the EU. Figures from the Office for National Statistics already report falling levels of business investment in the UK since the EU referendum.

The existing US tariffs are forecast by economists to trigger American job losses as well as weaker economic growth, despite the pledge by Trump that the taxes should save US jobs. The International Monetary Fund warns global growth could slow by as much as 0.5% by 2020, worth as much as $430bn (£328bn). There are fears the situation could spiral further, as countries retaliate by imposing ever higher taxes on one another’s goods.

The next major flashpoint will come when the US completes a national security investigation into car and truck imports, due before February next year.

For the UK, the key test for leaving the EU will come in October when the European Council meets to consider the Brexit deal, ahead of Britain formally withdrawing in March next year.

The disputes could rumble on for many years. Although the EU has hit back against US steel and aluminium tariffs with $3.2bn of levies on US goods, it has held back a second round of duties on $4.2bn with an implementation date of June 2021 to put pressure on the White House.


Richard Partington

The GuardianTramp

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