Free trade has been a hot topic recently. Both presidential candidates have made very pointed negative remarks about our various free trade agreements. The current thinking seems to be that free trade is "bad" and hurts the United States. Is this accurate? Not necessarily!
What is Free Trade?
As the name implies, free trade is trade between nations that is unfettered by tariffs, quotas, or other protectionist policies. The argument, first set forth by Adam Smith in "Wealth of Nations" is that nations should specialize in what they do best and buy from others what the others do best.
While free trade is beneficial, it is not without cost. The issue for free trade is one of "optics." The costs, e.g. lost jobs, are readily apparent. It is very easy to see the impact of a plant shutting down and moving production elsewhere. However, it is more difficult to add up all the positives which result from free trade, such as lower prices, increased choices, and improved efficiencies.
NAFTA: A Misunderstood and/or Misrepresented Case Study
Much anger has been directed towards 1994’s North American Free Trade Agreement (NAFTA) by various demagogues, starting with Ross Perot (the famous "huge sucking sound") in the early 90’s and continuing to this day. It is cited as a major cause behind the drop in manufacturing in this country. However, these claims do not hold up to closer scrutiny.
U.S. manufacturing employment peaked in the late 1970’s – well in advance of NAFTA. It seems impossible that a free trade agreement caused manufacturers to begin cutting jobs fifteen years before it went into effect (and more than ten years before negotiations on it even began!).
In fact, while U.S. manufacturing employment has fallen, output has continued to increase. In other words, we are producing more with fewer people, i.e. improved productivity. Since 1979 manufacturing employment is down 37 percent, but output has nearly doubled. This massive improvement in productivity is the true impetus behind the falling number of manufacturing jobs, dwarfing the impact from jobs moving abroad by a factor of ten. Free trade makes for an easy scapegoat, but it is not to blame for the bulk of the decline.
Bringing Back The Jobs
In light of this surge in productivity, bringing manufacturing plants back to the U.S. will not help as much as claimed. A large number of the lost manufacturing jobs are lost forever. Improved productivity means that even if operations are brought back to the U.S., it will take fewer people to generate the necessary output. In fact, forcibly bringing manufacturing back will end up hurting the domestic consumer by driving up prices for goods.
What about The Benefits?
As mentioned, demonstrating the benefits of free trade can be difficult. The biggest benefit is an increase in purchasing power for consumers due to lower prices. Unfortunately, most consumers don’t recognize prices are lower. Nonetheless the benefit is real. Various studies have put the annual benefit to U.S. households at around $10,000. For perspective, in 2014 the median U.S. household income was $54,000. In other words, that $10,000 additional purchasing power is a huge boost to consumers.
One fact missing from the anti-free trade rhetoric is how much U.S. manufacturing exports have grown because of free trade agreements. Going back to the NAFTA example, manufacturing exports to Canada and Mexico have grown over 250 percent in the wake of the agreement (source: Office of the United States Trade Representative).
Admittedly, the benefits of free trade will not be much of a comfort to anyone who has lost a job. And make no mistake, while free trade is a major net positive for the world, it can bring about wrenching changes. In the U.S., the negative impact of these changes has fallen most heavily on the working class and it has fueled significant resentment. The solutions to this problem are not simple and will likely not be cheap (and are well beyond the scope of this article).
Facing The Future
The evidence in favor of the benefits of free trade is overwhelming. But that is not to say that all will benefit equally. There are those who will suffer as economies transition and evolve. However, terminating free trade agreements and turning our back on the rest of the world is likely not the best solution.
This article was contributed by David Crossman, CFA, an Investment Manager at Bedel Financial Consulting, Inc.
Elaine E. Bedel, CFP, is CEO and president of Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. She is a featured guest each Wednesday on the WTHR (NBC, Indianapolis) Channel 13 News at Noon, "Your Money" segment. Elaine’s book, "Advice You Never Asked For… But wished you had," is available on Amazon.com. For more information, visit www.BedelFinancial.com or email Elaine at firstname.lastname@example.org.