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Tuesday, February 2, 2010

Free Trade Doesn't Work II

I recently finished up a phone conversation with Ian Fletcher who recently wrote the book, Free Trade Doesn't Work. We had a long discussion about the pitfalls and dangers of totally free trade. Here is a summary of that discussion. Of course, this discussion is a summary of the book.

Mr. Fletcher sees free trade pitfalls in two ways

1) totally free trade won't necessarily give the U.S. a geopolitical advantage

2)we aren't in a free trade environment and other countries practice mercantilism.

The Chinese are the best examples of a country that practices mercantilism. First, they manipulate their currency. They do this mostly by buying our bonds, assets, and real estate. By doing this, the Chinese strengthen our dollar and make our exports weaker.

Second, they manipulate their own society to encourage savings and discourage consumption. Doing this also discourages imports. As a result, China enjoys a consistent trade surplus. China is not unique in practicing mercantilism. Each country does it in their own way and many of them are detailed in the book. What's important is that mercantilism swings trade imbalance in the favor of a nation. By not engaging in mercantilism, the U.S. only perpetuates its own trade deficit.

Beyond this, totally free trade is not necessarily good for the U.S. Now, I believe in free trade based on the Econ 101 view of free trade. In that, one country has a lot of bananas and another has a lot of oranges. Free trade allows each country to have both oranges and bananas.

That's the simplified view. What if one country makes a lot of airplanes and the other country has a lot of bananas? Then, free trade becomes a lot more complicated. In fact, we can go all the way back to the beginning of the nation to understand this. Thomas Jefferson favored free trade and a society based on farming. Meanwhile, Alexander Hamilton favored some form of protectionism and a society based on manufacturing. The War of 1812 exposed our dependence on free trade. That's because we relied very heavily on French weapons. With the French embroiled in their own war, the U.S. was exposed without the necessary weaponry necessary to win.

The U.S. then engaged in much more sophisticated trade policy going forward.

Mr. Fletcher favors a flat tariff on all imports. He believes there must be a flat tariff to avoid politics and corruption. This will accomplish two things. First, our trade deficit will turn into a balanced trade policy. Second, it will relocate production of goods and services into the U.S.

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