Free Trade. Not too long ago I wrote a post about China’s holding of US debt, and what it would mean if China decided to sell the bonds it has accumulated. The subject was an offshoot of our trade negotiations with China.
Naturally one of our readers asked about the issue of trade, which is how so much debt wound up in China’s hands, and the original source of the debt imbalance between the US and China. The debt is a result of our ongoing trade deficits. Solve the trade imbalance, and the debt will take care of itself.
In this edition of PrepperNomics 107, I am going to try to address the question of trade.
Free Trade Theory
“Free trade” is an economic theory that says that if we have no restrictions on trade, people and countries, will be able to work on products they are best at, and trade for things made by others who are also doing what they are best at. By extension, entire countries can benefit by having free trade, so that all around the world people and countries are providing what they are best at producing, and then trading those goods for things they are not so good at producing.
However, this is a theory. In practice, free trade theory has some very significant assumptions. First, all the countries involved have to be at peace and willing to trust each other, allowing the trade to take place regardless of who benefits. Obviously, there are countries we are not at peace with, or don’t trust fully. Similarly, if you look at the world from the perspective of other countries, there are no countries that can fully trust all other countries. Everyone has someone they don’t trust.
Therefore, the world isn’t the kind of place that supports free trade in the sense that the theory assumes. The fact that we engage in economic sanctions illustrates clearly that there are countries which we don’t trust enough to have trade with, let alone free trade.
Reality
The reality is while Free Trade is theoretically desirable, even those countries that are our friends have negotiated trade agreements. Typically, trade negotiations go on for years, and then after an agreement has been in place for a while, it needs to be renegotiated, with each side trying to get the most favorable terms for itself. Ideally the result of all this negotiation is lower tariffs and other trade barriers for everyone involved, but seldom is the result totally free trade.
Furthermore, coming out of World War II, our economy was the dominant economy in the world. Since we were in an advantageous position, many of our so called “free trade agreements” were negotiated with the idea of rebuilding economies weakened by wars, or their own failed policies.
We also tend to use trade as a tool to affect national behavior. Be friendly with us on non-economic matters, and we’ll give you better terms in our trade negotiations. Consider our current issues with Mexico. We have problems with illegal immigration, drug flows, a trade imbalance, and NAFTA is being renegotiated. Obviously, we will give netter terms on NAFTA renegotiation is we can get progress on the problems of illegal immigration, drug flows, etc. NAFTA is not a free trade agreement, even though “free trade” is part of the title. It is a negotiated trade agreement.
While free trade is a useful academic theory for economics students, it doesn’t actually exist in world trade today. What exists are negotiated trade agreements between nation states.
The Dilemma
The real issue for trade negotiators is what are our goals in our relations with other countries? If we have a friendly, trusting, relationship with another nation, then agreeing to free, or at least freer, trade would be a worthwhile goal. Both countries can benefit. However, if our relationship with another country is less trusting, or even hostile, then economic progress may not be our goal at all.
In practice, our goals may be unclear, or we may have multiple goals that are in conflict. In order to have a successful trade negotiation, we must first have clarity about our goals. If you don’t know what constitutes success, how will you know if you succeeded?
What about China?
Our trade problems with China are a result of our changing relationship with China over time, and the changes in our goals that have come about as a result. During the Mao era, our relationship was decidedly unfriendly, and not at all trusting. Free trade was not a goal in that relationship.
Our relationship changed when President Nixon was in office. Our goal became building a better relationship with China and we agreed to trade with them on terms advantageous to China, in the belief that this would bring about still better relations and gradually develop their economy and normalize Chinese society. In the almost five decades since, trade with China has become significant, but the Chinese government is still officially communist, while our trade deficit with China has become a problem. It is reasonable to renegotiate given both the mixed success of the original agreement and changing circumstances.
China is still a potential military adversary, so whether free trade should even be a goal is an open question. However, assuming we continue to run trade deficits with China, we will continue to have a debt buildup of US debt in China. If China were to refuse to accept our debt (the topic of the earlier post) then they would not have a buyer for their goods. This would not be a painless transition for them.