Wednesday, August 8, 2018

Free Trade or Managed Mercantilism

Mary Anastasia O'Grady's WSJ coverage of Nafta talks included the following tidbit
auto-sector “rules of origin,” which dictate how much of a vehicle must be made in North America to qualify as duty-free when it crosses continental borders. 
In May, Team Trump proposed a new North American content requirement of 75%, up from the current 62.5%. It also wanted a new requirement that 70% of the steel and aluminum in Nafta vehicles be North American and new wage regulations that would require 40% of the value of North American cars and sport-utility vehicles—and 45% of Nafta trucks—be produced by workers making between $16 and $19 an hour. 
Mexico countered with 70% North American content, a 30% regional steel requirement and 20% regional aluminum. Market-based labor rates are important for Mexican competitiveness, but Mexico showed flexibility by proposing $16 an hour for 20% of the value of vehicles it makes. The U.S. rejected that offer. Now the two sides are trying to find middle ground.
Nafta and the like are often called "free trade agreements." Economists like me wonder, why does that take tens of thousands of pages? "We do not charge border taxes (tariffs), nor restrict quantities, nor will government purchases favor American companies." "We do the same." Done. That's free trade. This little snippet reminds us what trade pacts really are.

Of course, they are far better than the alternative, in which everything is tariffed, protected, managed, and individually negotiated.


  1. "be produced by workers making between $16 and $19 an hour"

    Putting an upper limit in there seems odd.

    If the Americans and Mexicans are having this discussion then it makes sense that Canada is not participating. Wages in Canada are high enough that it will not have a dog in the fight.

  2. "and individually negotiated." ... Or not negotiated ... i.e. tariffs just slapped on willy nilly... which is where we seem to be going.

  3. Yes, there is the David Ricardo diagram, showing output is maximized by free trade. Portugal-England mutton-wine! Comparative advantages rule!

    Forgive this long post. But I am a wag, no dogs in the fight, I can believe what I want to believe.

    So I read that Singapore is a free-trade citadel, and prosperous because of it. And in fact in Singapore per capita GDP PPP is 50% higher than that of the US.

    So I earnestly read up on Singapore.

    Okay, the big stuff:

    All the land in Singapore is owned by the government. There is no private property. Oh, that.

    Singapore provides free capital to select businesses and industry.

    80% of Singaporeans live in government-built-subsidized housing.

    Okay, so aside from providing free land, infrastructure or capital to favored industries and businesses, and dominating housing, Singapore is free-market.

    Well, not quite…

    Read up on Jurong Island. Amazing! It is an entire island built by the government of Singapore to house petrochemical industries, in which many the government of Singapore is a JV partner. Singapore also owns 49% of a huge (7,000 workers) shipbuilding facility on the island.

    Tidbits: The government of Singapore owns Singapore Airlines. Really, this is getting silly—does the US government own a commercial airline?

    But then Singapore also owns the Singapore airport. Gee, I wonder how gate assignments and landing times are worked out. Through free markets? I suspect Singapore Airlines gets a fair shake.

    And Singapore Airlines, when they buy fuel from Singapore-owned oil refiners–--maybe they buy wholesale? Do Singapore Airline workers qualify for Singapore-built housing? No one knows.

    There is tons more, and I really just scratched the surface on amazing Singapore.

    The real deal: Singapore is a public-private economy, the way grey paint is black and white. Free markets have nothing to do with it.

    Oh! There is a 7% sales tax on all imported goods and services, but not on exports.

    So importers and domestic producers pay the freight to help run Singapore, but not exporters, who piggyback. That is an export subsidy.

    But many observers say the Singapore export-subsidy story is even deeper that that—the term “fungible tariffs” is used.

    Like this: So, a Singapore company says to the government (and its equity partner or banker, and landlord), “You know imports are hurting us.”

    Government official: “Okay, we can rebate your sales tax through a rent reduction.”

    So the importer pays a 7% “sales tax,” but the domestic competitor-producer gets a rent break, offsetting its sales tax.

    Free markets in action!

    BTW, according the the IMF, Singapore runs a trade surplus equal to 18% of GDP, the world’s highest. As I said, heir per capita GDP PPP is 50% higher than that of the US.

    I am a wag. No one ever mistook me for a serious scholar.

    Dare I ask, is there such a thing as “free,” “fair” or “foul” trade?

    Those ideas do not really exist in Singapore, or to a greater or lesser extent, anywhere else either.

    More in my next comment.

  4. Part II apologies….

    Okay, I thought, "I am just a wag. Maybe I do not understand why Singapore is a free-market mecca."

    So I turned to a Singapore economics scholar.

    The above is a study published in the Singapore Economic Review. I would guess that is authoritative, at least on matters Singapore.

    From abstract:

    “Compared with other dynamic Asian economies, the Singapore government’s approach to intervene in the economy is both more extensive and more intrusive, but with a narrow focus on GDP growth and surplus accumulation as the primary objectives.”

    More intrusive than other Asian economies? Boy, that is saying something, Japan Inc.? S Korea chaebols-governance? Mainland China?

    Another quote:

    “Hardly any major strategic or structural change in Singapore in the past five decades took place without the involvement of or a strong push from the government.”

    Eeek! But more!

    “The government was not averse to using GLCs (government money) to undertake investments that might intrude into the space of the private sector but which it considered strategic for the long term growth of the economy.”

    Huh? This is Singapore?

    The author is TAN KIM SONG School of Economics, Singapore Management University 90 Stamford Road, Singapore 178903….

    In the last 10 to 15 years, there was a move towards globalization and perhaps more free markets in Singapore, notes author Song.

    “Over the past 10 to 15 years, there has been a major strategic shift to transform Singapore into a “global city”. While the average GDP growth rate remained high during this period and the per capita income of the country continued to surge, developments in other areas of the economy have been less satisfactory. Today, Singapore has one of the most unequal income distributions (as measured by the Gini coefficient) among developed countries, a large segment of the population suffers from long years of wage stagnation, and productivity growth performance is dismal compared with that of other dynamic Asian economies.2 Despite the nation’s wealth and the high level of savings at the macroeconomic level, there are serious concerns about the adequacy of savings for retirement at the individual level. Meanwhile, the quality of life is seen to have declined significantly over the past 10 to 15 years when the population rose sharply without the necessary increase in provision of public services, infrastructure and public goods in general.”

    You know, the more I read, the less Singapore resembles the descriptions provided by Westerners….

    Still, I think Singapore’s industrialization policy has worked better than Detroit’s de-industrialization policy….

    If comparative advantages are artificial creations of government….then what is "free trade"?

  5. Trump does not seem to be able to comprehend that if Mexicans cannot find jobs in Mexico, they will come to the US to find work. Wall or no wall. If he really wants to be able to cut illegal immigration, he needs to be in the forefront of bolstering the Mexican economy.

  6. A small quibble about the headline: what we've got now shouldn't be called mercantilism. Mercantilists had a coherent set of values (nationalism) and an economic model that they believed would advance those values (maximize gold reserves). They were, of course, wrong about the importance of gold and we can argue about the relative importance of nationalism and individualism. But there is not a trace of principled mercantilism in Trump's trade policy. What we have now is industrial policy designed to make politicians more powerful. (Essentially the same point that George Will made in that column inspired by John’s earlier blog post. If you’re a regular reader of this blog, go look up the column. It’s very nice.)

  7. The auto-pact between Canada and the US signed on January 16, 1965, by Lyndon B. Johnson, and Dean Rusk for the USA and Lester B. Pearson and Paul Martin, Sr., for Canada, is a case that argues for trade agreements between a smaller economy and a larger economy in an industry sector that offers gains from scale economies in both. The history illustrates the problems faced by the smaller economy (Canada) and the solutions that were applied both in terms of tariff imposition and through a negotiated trade agreement---

    The original Automotive Products Trade Agreement of 1965 was a short document. Consumer surplus increased, and scale efficiencies for the American owned branch plants in Canada improved. The agreement lapsed after Canada joined the WTO, under pressure from Japanese and European automobile manufacturers with manufacturing and assembly plants in North America. The trade agreement was cancelled in the year 2001.

    During the life of the trade agreement, the trade balance that developed in favour of Canada proved to be an irritant (then as now). US interests argued that Canada had not lived up to the terms of the agreement, specifically the 'safeguard' provisions which were supposed to have been temporary, and Congress referred the matter to the International Trade Commission for investigation. The Nixon administration decided to cancel the agreement in response to a severe balance of payments crisis in 1971, but failed to do so.

    The US position favoured "free trade", over an agreement that gave trade concessions to the weaker party (Canada). That was never going fly with the Canadian government. "Fearful of a declining auto industry and worried about the trade deficit, the government of Prime Minister John Diefenbaker had in 1960 appointed Vincent Bladen, a University of Toronto economist, to study the industry. In his report, Bladen rejected free trade as a solution because, he argued, Canadian industry was unprepared and would be much diminished. He also rejected higher tariffs as counterproductive. Instead, Bladen proposed measures to increase Canadian content in auto products by allowing companies to import vehicles and parts duty-free, provided they met Canadian content requirements." Op.cit.

    Free trade must be mutually beneficial between the trading parties. Where the economic power lies entirely in then hands of one party, free trade is not a option that the political authority of the other party readily adopts.

    The current state of negotiations around renewal of NAFTA, along with various trade actions by the US Dept. of Commerce against Canadian-source imports over the past decade or so, would indicate that the smaller partner in the agreement having achieved some measure of relief through the agreement is going to be loathe to give up those achievements readily.

    In a game against Nature, odds favour Nature to win.

  8. Another clear example of the government's insatiable need to regulate. How many government jobs, benefits packages, pensions and offices are created to oversee and regulate all of this?

    Government is about more government

  9. "'We do not charge border taxes (tariffs), nor restrict quantities, nor will government purchases favor American companies.' 'We do the same.' Done."

    If only this were the consensus view. Most US economists seem to take the view that unilateral elimination of taxes on imports is free trade and that the behavior of trading partners is irrelevant: getting cheap stuff in the US is the be all and end all of trade policy. And too often only taxes that are labeled "tariffs" are all that is considered. Singapore, for example, is considered to be a free trader because it has low tariffs, despite a 7% goods and services tax on all imports (but not on exports) that will likely increase to 9%.

    US producers are at a comparative disadvantage to the rest of the world when it comes to taxation and regulation. US tax policy favors importation of goods and services over domestic suppliers. US regulators are inferior in quality and much more oppressive than those in other countries.

    Until US economists take into account the larger picture and come up with ways to address these disparities (hint: replace corporate income taxation with a VAT that applies to imports as well as domestic producers, support Trump's deregulation agenda), US politicians will be right to ignore the submissive, one-sided cant of typical economists, and pursue trade agreement work arounds that ameliorate the negative domestic effects of the US's comparative disadvantages.

  10. What happens if the Mexican peso devalues like in 1995?

  11. Words such as Free Trade Agreement confuse people. Let’s call them what they are, “Trade limitation agreements” or “Consumer restriction agreements” - maybe someone can improve on this attempt. If commentators call a spade a spade, more people will realise that these agreements are bad for consumers.

  12. Why does a trade agreement contain minimum wage provision in another country that uses a different currency?

    1. I lack the ability to explain concisely, but the 10,000 foot view is that wages, taxes, and exchange rates are (to some extent) co-dependent.

      So the wage limit serves a set of bounds on the fundamental assumptions driving the agreement. If wages in Mexico doubled overnight, neither country would have made the deal they thought they were making.

  13. Recent news reports shed some light on the impact that the administration’s tariff play is having in the US. In the case of steel commodities where the administration has imposed 25% tariff rates and this week decided on 50% tariff rates on Turkish steel (4% of US imports of semi-finished and finished steel), the effect of the tariff rate hikes is evident in the steel futures prices: "Steel futures on Friday [10-Aug-2018] were up 1 percent at $907 per ton on the New York Mercantile Exchange, but are up 46 percent from $621 per ton a year ago." [ ] In this case, the cost of steel pipe used in oil and gas transmission pipelines that transport crude oil from Permian play fields in Texas to refineries on the coast is higher than originally planned for, and the capital projects constructing new pipelines to carry the higher volumes of crude oil from the fields to the processing plants may be in jeopardy of cancellation or curtailment.

    Similar action in the automobile manufacturing sector being contemplated by the administration (25% import duties on auto parts and finished vehicles) will lead to higher costs for American auto manufacturers and ultimately for American consumers. Negotiations of the North American Free Trade Agreement taking place between Mexico and the USA reportedly have the US negotiators demanding a provision in the reworked agreement that would permit the US to impose 25% import duties on cars and trucks entering the US from Mexico if those vehicles are built in new manufacturing facilities constructed in Mexico after the revised agreement is signed. If this provision is added, the term "Free" in the title of the agreement should be expunged from the document.

    The rationale for the administration's punitive application of trade tariffs is to extract concessions from trading partners---in the case of tariff rate of 50% on imported Turkish steel, the effort is intended to force Turkey to release a US person from detention under Turkish security laws. In the case of Canada, Mexico and Europe the object is to extract trading concessions, although in the case of Canada the measures appear to have taken on a beggar-thy-neighbor aspect judging from the president’s recent extemporaneous remarks.

    In view of the trade actions by the administration this year, there is little evidence in support of a contention that the US is in favor of free trade. The administration may signal support for “managed trade”, but only if that results in trade outcomes favorable to US interests; otherwise, the US will impose punitive tariff rates to tilt the table against its trade opponents at every opportunity. We can expect to see higher tariff rates applied to US export products entering foreign markets and reduced global trade opportunities as a result going forward.

  14. It's easy to support a position free trade, i.e. trade partners drop all trade barriers and we will do the same. But what do you do if you make that offer and your trading partners say "No thanks"? Or worse they agree but "cheat" on the deal?

    And what is free trade in practice? If you are hairdresser in OK and want to open a shop in TX, you have to meet local and state licensing requirements, also known as non-tariff barriers. It's not just hairdressers. From landscapers to lawyers, health insurance to health care, we have a numerous trade barriers erected between the states.

    If we do not have free trade between the U.S. states, why would we expect it for trade internationally?

    1. You're making the mercantilist mistake -- the point of trade is to export only, so it's only good if they let us sell to them. And conversely, since free trade is good internationally, interstate restrictions are a bad idea too. The constitution tried to enforce a free trade zone, states are very clever at getting around that.

    2. The 10th amendment to the constitution limited the powers of the federal government to an enumerated list of powers, and reserved to the states or the people all other powers not so enumerated.

      The only restriction on state powers is that they must not discriminate against citizens of another state in the union. Thus, it is permissible that a state impose a licensing requirement on barbers, for example, who provide that service within the state. A barber from another state need only meet the licensing requirements of the state in which he wishes to practice that art, and he is free to do so provided he meets the state's licensing requirements. Likewise for professional engineers; and, it is not uncommon for professional engineers to be licensed in two or more states, e.g., California and Arizona, or Washington, Oregon and Idaho, and practice in both or in several states simultaneously while resident in only one.

      The only control over commerce in such professions is the requirement for a license which is not hard for qualified individuals to come by, certainly no harder for one from another state than it is for one from the state itself. The principle extends to licensing between provinces of Canada and states of the United States where professional engineering accreditation bodies will accredit a professional engineer licensed in the State of Washington with accreditation to practice engineering in a professional capacity in the Province of British Columbia. This is the principle of reciprocity between foreign jurisdictions and is an important factor in trade in international services, such as the recent construction of a major highway bridge across the Fraser River at Port Mann, British Columbia, by an American engineering construction firm for the government of British Columbia.

      To the extent that the only impediment to provision of services across state boundaries is a state-issued license to practice within the state, the USA is as close to a "free trade zone" as one can come without re-writing the 10th amendment to expand the enumerated list of federal powers at the expense of the powers reserved to the states and the people.

  15. "states are very clever at getting around that."

    Does anyone know why COUNTRIES also try so hard to avoid free trade? I cannot think of a reason, but it feels like there must be some explanation (every nation in history being too foolish to understand basic economics seems unlikely).

    I mean, for states the answer is obvious: politicians greatly benefit from "exporting the tax base" to other states, while the economic impact tends to be muted. But this sort of reasoning doesn't really hold at the national level, so it's always struck me as a bit of a puzzle.


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