The Free-Trade Paradox
by James Surowiecki
All the acrimony in the primary race between Barack Obama and Hillary Clinton has disguised the fact that on most issues they’re not too far apart. That’s especially the case when it comes to free trade, which both Obama and Clinton have lambasted over the past few months. At times, the campaign has looked like a contest over who hates free trade more: Obama has argued that free-trade agreements like NAFTA are bought and paid for by special interests, while Clinton has emphasized the need to “stand up” to countries like China. Two weeks ago, both senators signed on as sponsors of a new bill that would effectively impose higher tariffs on China if it doesn’t revalue its currency. The candidates are trying to win the favor of unions and blue-collar voters in states like Ohio and West Virginia, of course, but their positions also reflect a widespread belief that free trade with developing countries, and with China in particular, is a kind of scam perpetrated by the wealthy, who reap the benefits while ordinary Americans bear the cost.
It’s an understandable view: how, after all, can it be a good thing for American workers to have to compete with people who get paid seventy cents an hour? As it happens, the negative effect of trade on American wages isn’t that easy to document. The economist Paul Krugman, for instance, believes that the effect is significant, though in a recent academic paper he concluded that it was impossible to quantify. But it’s safe to say that the main burden of trade-related job losses and wage declines has fallen on middle- and lower-income Americans. So standing up to China seems like a logical way to help ordinary Americans do better. But there’s a problem with this approach: the very people who suffer most from free trade are often, paradoxically, among its biggest beneficiaries.
The reason for this is simple: free trade with poorer countries has a huge positive impact on the buying power of middle- and lower-income consumers—a much bigger impact than it does on the buying power of wealthier consumers. The less you make, the bigger the percentage of your spending that goes to manufactured goods—clothes, shoes, and the like—whose prices are often directly affected by free trade. The wealthier you are, the more you tend to spend on services—education, leisure, and so on—that are less subject to competition from abroad. In a recent paper on the effect of trade with China, the University of Chicago economists Christian Broda and John Romalis estimate that poor Americans devote around forty per cent more of their spending to “non-durable goods” than rich Americans do. That means that lower-income Americans get a much bigger benefit from the lower prices that trade with China has brought.
Then, too, the specific products that middle- and lower-income Americans buy are much more likely to originate in places like China than the products that wealthier Americans buy. Despite a huge increase in imports from China—they sextupled as a percentage of U.S. imports between 1990 and 2006—Chinese products are still concentrated mostly in lower-price markets. (By some estimates, Wal-Mart alone has accounted for nearly a tenth of all imports from China in recent years.) By contrast, much of what wealthier Americans buy is made in the U.S. or in high-wage countries like Germany and Switzerland. This is obvious when it comes to luxury goods—Louis Vuitton bags, Patek Philippe watches, and so on—but it’s also true of many other goods, like electronics, kitchen appliances, and furniture, categories in which American and European manufacturers have continued to thrive by selling to the high-end market. According to the Yale economist Peter K. Schott, machinery and electronics products made in developed countries sell in the U.S. for four times the average price of Chinese products. And, since the late nineteen-eighties, that price gap has widened by almost forty per cent.
This may not always be the case; as China’s economy continues to boom, its companies will likely move up the quality ladder and, eventually, become serious competition for high-end American and European manufacturers. But for the moment the benefits of free trade with China, at least when it comes to shopping, are concentrated overwhelmingly among average Americans. And the result is that, in the past decade, the products that they spend more on have become a lot cheaper compared to the stuff that rich people spend more on. Broda and Romalis, in their recent paper, calculate that between 1999 and 2005 alone the inflation rate for lower-income Americans was almost seven points lower than it was for the wealthiest Americans. That means that free trade with China has made average Americans, at least as consumers, much better off—in the sense that it’s made their dollars go further than they otherwise would have.
Now, there’s a lot that’s left out of this equation, such as the fact that free trade may help richer Americans by increasing corporate profits. And cheap DVD players may not, on balance, make up for lost jobs. But the reality is that if we toughen our trade relations with China the benefits will be enjoyed by a few, since only a small percentage of Americans now work for companies that compete directly with Chinese manufacturers, while average Americans will feel the pain—in the form of higher prices—far more quickly and more directly than rich Americans will. Obama and Clinton, in their desire to help working Americans—and gain their votes—are pushing for policies that will also hurt them. ♦
Blame Washington, Not Oil Companies
Energy: Senate Democrats, dragging executives from five major U.S. oil companies before them for a second day, say they're alarmed by our "failed" oil markets. What they should be is ashamed.
After all, it's mostly the fault of the Congress that we're in this mess. True, the Big 5 announced profits of $36 billion in the first quarter, as oil breached $100 a barrel and just kept going. This prompted nothing but contempt from Illinois Sen. Richard Durbin this week: "Where is your corporate conscience?" he asked the oil executives, forced to sit and listen.
Others concluded that this must be a market problem. "We need to get prices under control," said Sen. Herb Kohl of Wisconsin. "We can only conclude that the oil markets have failed."
Well, markets have failed. But the failure is due to Congress' refusal to let oil companies drill on federal lands, thereby cutting sharply into our supply of crude as world demand grows and prices soar both here and abroad.
Congressional ignorance of basic laws of supply and demand is at once bizarre, breathtaking and frightening. For example, the American Thinker Web site this week took note of a speech delivered by New York Democratic Sen. Chuck Schumer on May 13. In it, he urged the U.S. to force Saudi Arabia to pump a million barrels a day more of oil — which Schumer claimed would slash the price of crude by $25 a barrel.
What Schumer didn't say was that 1 million barrels is exactly the amount of extra oil the U.S. would today be pumping if President Clinton hadn't vetoed drilling in the Arctic National Wildlife Refuge in 1995. Despite this, Schumer still opposes drilling in ANWR.
As for those massive oil profits, Democrats want to slap Big Oil with a "windfall profits tax." In fact, since 2002 the U.S. oil and natural gas industry has earned about 8.1 cents per dollar of sales — exactly the same as all U.S. manufacturing, excluding autos. Not much of a windfall.
To listen to Congress, you'd think oil companies don't pay taxes. Nothing could be further from the truth. In 2006 alone, according to the American Petroleum Institute, U.S. oil companies paid some $138 billion in taxes to the IRS — and that doesn't include special oil severance, sales and use taxes companies also had to pay.
The total effective tax rate on oil is about 40%. This compares with a top income tax rate of 35% for all corporations. If anything, Big Oil is overtaxed.
A recent study by Ernst & Young notes that the same Big 5 oil companies that Congress harshly criticized this week earned $662 billion from 1992 to 2006. A lot of money, to be sure. But keep in mind that they invested $765 billion over the same stretch to bring us more oil from ever smaller pieces of the Earth's surface.
We are in the midst of a major global oil-supply crunch — one that can only be broken by Congress and other governmental bodies around the world taking concrete action.
A report released Thursday by the Department of the Interior notes that most of the oil and 40% of the natural gas under public lands in the U.S. is off-limits to drilling. That's about 19 billion barrels of oil and trillions of cubic feet of natural gas.
A separate report, this one from the International Energy Agency, warned of a looming global supply crunch resulting from the failure of governments — not private oil companies — to invest more or open up their lands for exploration and development.
One of the oil business's dirty secrets is that only 6% of all reserves are controlled by investor-owned oil companies such as those demonized by Congress. The rest are controlled by governments, one way or another. And 11 of the 15 largest oil companies are government-owned. Government is the problem, not "Big Oil."
That's why this ridiculous blaming of oil companies must stop, and why the companies must be allowed to get back into the business of pumping oil. Once this happens, we'll find that the markets that ignorant and demagogic politicians called "failed" will once again turn out plentiful energy at prices people can afford.
The Death of Conservatism Is Greatly Exaggerated
Recent congressional losses, President George W. Bush's unpopularity, and bleak generic ballot poll numbers have conservatives fearing the "liberalization" of America – a move toward secularization, the growth of government, stagnation, mediocrity and loss of freedom.
Yet there is still a way to revive the conservative cause. Doing so will require avoiding the traps of pessimism or election-year quick fixes. Conservatives need to stand back for a moment and think about our philosophical first principles.
Conservatives value the lessons of history and respect faith and tradition. They are skeptical of mass movements, perfect solutions and what often passes for "progress." At the same time, they recognize that change is inevitable. They also know that while man is prone to err, he is capable of great things and is meant to be free in an unfettered market of ideas, not subjugated by a too-powerful government.
These were the principles relied upon by our Founding Fathers, and which paved the way for a Constitution that delineated the powers of the central government, established checks and balances among its branches, and further diffused its power through a system of federalism. These principles led to a market economy, the primacy of the rule of law and the abolition of slavery. They also helped to establish liberal trade policies and to meld idealism and realism in our foreign and military policies.
The power of conservative principles is borne out in the most strong, prosperous and free country in the history of the world. In the U.S., basic constitutional government has been preserved, foreign tyrannies have been defeated, our failed welfare system was reformed, and the confiscatory income tax rates of a few decades ago have been substantially reduced. This may be why the party where most conservatives reside, the Republican Party, has won seven of the last 10 presidential elections.
Still, a lot of the issues that litter the political battlefield today put conservatives on the defensive. What are we going to do to fix the economy, the housing market, health-care costs and education? Some conservatives try to avoid philosophical confrontation with liberals, often urging solutions that would expand the government while rationalizing that the expansion would be at a slightly slower rate.
This strategy simply has not worked. Conservatives should stay true to their principles and remember:
- Congress cannot repeal the laws of economics. There are no short-term fixes without longer term consequences.
- In a free and dynamic country with social mobility, there will be great opportunity but also economic disparity, especially if the country has liberal immigration policies and a high divorce rate.
- An education system cannot overcome the breakdown of the family, and the social fabric that surrounds children daily.
- Free markets, not an expanding and more powerful government, are the solution to today's problems. Many of these problems, such as health-care costs, energy dependency and the subprime mortgage crisis, were caused in large part by government policies.
It's not that conservatives today no longer believe in the validity of these principles. They just find it difficult to stand strong when the political winds are blowing so hard against them. To be sure, standing by conservative principles does not always guarantee success at the ballot box – it did for Ronald Reagan, but not for Barry Goldwater. But abandoning these principles doesn't ensure victory either. Circumstances often play the deciding role. Is there any doubt that the Carter administration's misery index and the Iranian hostage crises allowed Reagan to prevail in 1980?
In this unpredictable world, conservatives should adhere to their fundamental ideals. These ideals have brought our country much success, and may well win the day again. Conservatives must have faith that, more often than not, Americans will make the sacrifices necessary to preserve national security and prosperity.
A political party that adheres to conservative principles should have continuing success – especially if its leadership believes in those principles and is able to articulate them.
Mr. Thompson, a former U.S. senator from Tennessee, was a candidate for the 2008 Republican presidential nomination.
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