International trade has become a focal point of U.S. political debate, with antitrade tirades and protectionist rhetoric dominating stump speeches and media coverage.
This is is especially worrisome, given that recent opinion polls show that supporters of both major parties believe trade agreements result in fewer jobs and lower wages. Often ignored in this debate is the law of comparative advantage, developed in 1817 by English economist David Ricardo, who demonstrated that free trade almost always benefits both countries involved. In our view, the same holds true today when countries, doing what they do best, produce more and exchange it for a greater amount of all other goods.
Trade is not a zero-sum game
To some, including a number of the presidential candidates, the notion that every country can benefit from trade may seem counterintuitive. After all, isn't there always a loser for every winner? Isn't trade a zero-sum game? Fortunately, the answer is no. According to the law of comparative advantage, every nation can, and does, win. This law demonstrates the power of trade to deliver growth and prosperity. International trade has been a key driver of improvements in our standard of living since World War II. For example, the White House's Council of Economic Advisers concluded that U.S. consumers have gained 29% of their purchasing power from trade.1
So why, oh why, has trade policy become such a prominent issue in this year's presidential campaign? Protectionist sentiment has grown largely because the United States was caught off guard by China's rapid emergence in recent decades as a key player in world trade. During the post-World War II period, the vast majority of international trade occurred between developed-market economies, which typically possess similar labor costs. Although U.S. imports from low-wage emerging markets have historically been relatively modest, this changed dramatically in the late 1990s as China prepared to join the World Trade Organization. Amid the resulting flood of imports from China, the United States lost 2.4 million jobs from 1999 through 2011, according to economists' estimates. It is important to note, however, that some portion of those jobs was lost because of productivity gains resulting from improvements in technology, not as a result of trade.
Easing the negative impact of free trade
Recent opinion polls have made it clear that aid for displaced workers is critical to securing broad public backing for expanded trade. Unfortunately, trade adjustment assistance programs have been woefully inadequate, in our view, even though the cost of credible programs would represent only a small percentage of the total gains from trade. In principle, the winners in a world with expanded trade should be able to compensate the losers, so that everyone gains. In practice, this has proved difficult due to political and budget constraints.
The shock caused by China's emergence in global trade has clearly exposed fault lines in America's economy and created a strong political backlash against trade. In some ways, protectionists have already succeeded in beginning to turn back the globalization clock. Over the last eight years, protectionist policies have expanded globally and, in our view, this proliferation has helped to bring about the longest period of trade stagnation since World War II.
Further, it has already become increasingly difficult to negotiate and ratify new trade agreements, making it likely that trade growth will continue to stagnate well into the 2020s. These developments also increase the risk of trade wars and skirmishes, especially with China. Should we see an unwinding of existing trade agreements, huge job losses are to be expected globally, making us all extremely worse off.
Market impact of protectionism
Even the anticipation of a trade war could cause global stock markets to sink. Among U.S. equities, a trade war would hurt international companies more than domestically oriented firms, damage large-cap stocks relative to small caps, afflict sectors such as information technology that depend on intellectual property rights, and burden companies that depend on global supply chains. Performance of most international equity markets could worsen, especially those of countries with current account surpluses that need to, in effect, import demand.
Regardless of whether conditions dramatically deteriorate, it is clear that the forces of globalization are sputtering. While protectionist rhetoric is understandable and often heartfelt, it reflects faulty logic and bad economics, in our view. We expect that stepping back from globalization would worsen U.S. unemployment, reduce living standards, and dampen future economic growth rates. Avoiding this fate requires that policymakers provide more help for dislocated workers, push back against protectionist pressures, and implement policies to further liberalize trade, especially in services. While that's a tall order, it deserves the full focus and attention of the next administration.
1 The Economic Benefits of U.S. Trade, White House Council of Economic Advisers, May 2015.