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ZAPP: Deficit illustrates how trade policies must evolve

Our trade deficit has become a major issue in this year’s irregular presidential campaign.

Donald Trump used it to distinguish himself from the other Republican candidates who accepted their party’s traditional support for “Free Trade.” Sen. Bernie Sanders used it to attack the presumptive nominee of the Democrat Party, Hillary Clinton, for her early advocacy for the proposed TransPacific Partnership and her husband’s embrace of the North American Free Trade Agreement. Clinton now opposes the TPP as currently written.

This issue confounds most economists. Prof. Nick Mangee at Armstrong State University recently reported a survey which found that over 90 percent of American economists believe that unfettered trade benefits our standards of living.

Most business graduates can still recite how when countries exchange goods or services according to their comparative advantages, citizens of both nations realize higher real incomes. So why suddenly are politicians gaining popularity by questioning agreements which lower or eliminate barriers to trade?

Let’s start with the numbers.

Our trade deficit this year will be approximately half a trillion dollars. This helps explain why our recovery from the terrible recession of 2008-9 is so sluggish. Under normal circumstances, the federal budget deficit would have stimulated faster growth. With the trade deficit, however, most of its stimulative effect is lost. As we say in Economics 101, $500 billion of this deficit spending leaks out of our circular flow via the trade deficit.

Our trade deficits with specific countries raise further concern. Using 2015 data, we had deficits of $367 billion with China, $61 billion with Mexico, and almost $16 billion with Canada. These losses are expected to be higher this year.

Are the economic theories of trade wrong? Maybe it is more accurate to say that these theories which were developed 200 years ago could be enhanced by taking into account the realities of the global economy today.

The concept of comparative advantage was developed when countries had unique factor advantages. These included minerals, soil attributes, climate, topography, growing seasons, access to water and other natural resources and a head start in technology.

The theories, therefore, never envisioned the possibility of a developed economy having to compete with countries where a worker could produce manufactured goods while earning the equivalent of $1 an hour.

Most resources and basic technologies are now commodities which are available to producers everywhere. Accepting policies which simply remove barriers to trade therefore results in downward pressure on wages in the developed economies, a process called the race to the bottom.

This situation is further complicated by the unequal ways the benefits and costs of international trade are realized. The benefits of our trade are spread thinly across all our citizens.

Yes, I am glad that I can save $20 on my $500 flat-screen TV but this does not motivate me to support a candidate for office on this issue alone.

The worker or company owner whose livelihood are threatened by cheaper imports, however, view this as the main issue and vote accordingly.

What is to be done? While we wait for a new comprehensive theory of trade, a few points seem relevant. First, traditional protectionism is not the answer. We need to find ways to maintain the benefits of trade while reducing its costs or threats.

Next, we should differentiate between free trade and fair trade. The former means no interference in the flow of goods and services. Fair trade suggests that in order for trade to benefit both countries, firms operating in them must face similar rules and regulations. In other words, it is folly for us to have free trade with countries which have no constraints on child or prison labor, environmental degradation, harm to worker health and safety, or which provide subsidies and other unfair assistance to their companies.

Achieving fair trade alone would not solve our trade deficit. Last year we had a deficit of $172 billion with Europe which has equivalent, if not stronger, regulations than our firms face at home.

In the long run, our hope for eliminating our trade deficit and possibly achieving a surplus, lies in the development of a competitive advantage in knowledge, in both research and development and our human capital.

Why do we currently have surpluses in the trade of aviation technology and military equipment? Our firms in these industries benefit from our taxpayer-funded expenditures in research and development through Defense Department contracts. This knowledge advantage enables our producers to beat their competition in the global market. This is not the laissez-faire market at work but a strategic investment our society has made in industries related to our national defense.

Many years ago the government of France decided that they would become the world leader in high-speed rail transport. After decades of public investment in research and development, French firms now export this equipment around the world. We need to do the same: Identify markets in which public investments in R & D would provide American firms competitive advantage which could not easily be copied in the marketplace. Firms receiving such funding would have to agree to keep all jobs in the country.

Finally, we can enhance the ability of our workforce to create value by investing in their knowledge. Sweden provides an example of how human capital expansion produces a higher standard of living. Sweden, with its generous vacation and holiday benefits, is famous for employees working fewer hours each year than their colleagues in other countries.

With unemployment at 6.6 percent compared to 4.9 percent here, their country still enjoys a GDP per capita of over $50,000. When Swedes work, they are more productive than employees elsewhere.

Sweden achieves this by investing heavily in the education of its workers. Young people may qualify for up to 24 months of job training in fields of labor shortages while receiving generous unemployment benefits. Frequently they are then hired by private firms which receive job-creating subsidies for the initial period of employment. The government also requires that older workers who lost their jobs attend professional training in order to receive unemployment compensation.

Value-added production will require that we lead in the knowledge of our firms and employees. This is the only way for us to have the benefits of trade without allowing its negative effects to curtail it.

 

Kenneth Zapp is professor emeritus at Metropolitan State University and a mentor for SCORE Savannah.   

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