How Capitalism Will Save Us

by Steve Forbes

  Facing higher costs, companies would generate less profit. Less wealth would be created for businesses and people. New York’s standard of living would plummet. The Empire State would devolve into Honduras on the Hudson.

  Let’s hammer this point home: What if you personally had to produce at home everything you consumed? No longer could you pay outsiders to provide products and services. You’d have to make your own clothing, grow your own food, do your own home repairs, and everything else. This totally do-it-yourself lifestyle was how subsistence farmers lived at the time of our independence. Most people today would consider doing so grossly impractical and inefficient.

  Think of all the people who never would have developed their skills had they been forced to devote their energies to meeting basic needs. What if Michael Jordan had had to spend time farming and sewing his own clothes? He never would have become the greatest basketball player in history.

  Most of us can easily see the absurdity of prohibiting trade between states or individuals. Yet restricting trade between nations is equally foolhardy. Adam Smith realized this back in 1776 when he wrote An Inquiry into the Nature and Causes of the Wealth of Nations:

  It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.1

  British economist David Ricardo described the benefits of international trade in his classic nineteenth-century work On the Principles of Political Economy and Taxation.2 He explained that free trade enables countries with differing resources and capabilities to each produce more goods for lower cost than would be possible if each nation separately manufactured the same products. This is known as the theory of comparative advantage. It is the reason why trade between nations, when allowed to flourish, has been a powerful driver of economic growth throughout history.

  Freetrade bashers forget that today’s era of global trade was a response to the searing lessons taught by the Smoot-Hawley Tariff. Imposed in 1930, the levy raised import duties on a mind-numbing array of goods to record levels, igniting the worldwide trade war that plunged the world into the Great Depression.

  Chastened by that experience, some 23 nations came together after World War II and signed the General Agreement on Tariffs and Trade (GATT) in 1947. In 1995, GATT was replaced by the World Trade Organization, which included 153 nations and nearly 98 percent of global trade.3Since the trend toward global trade began, most import quotas have been eliminated. According to Rod Hunter of the Hudson Institute, average tariffs fell from nearly 40 percent to 9.7 percent. America’s import duties average a mere 3.5 percent. Europe’s average is 5 percent.4

  This loosening of trade barriers brought a thirtyfold increase in global trade that has been a boon to U.S. prosperity. In a widely cited 2006 study, economists Scott C. Bradford, Paul L. E. Grieco, and Gary Clyde Hufbauer estimated that overseas trade had added between $800 billion to $1.4 trillion in annual income to the U.S. economy since World War II.5That translates into a total gain in products, goods, and services of about seven thousand to thirteen thousand dollars per household. This enormous benefit far exceeds the cost of worker dislocations that trade produces—estimated at about $54 billion or less.

  Much of this growth has occurred in the last thirty years. One of the reasons that the 1970s had a lower standard of living was that the United States did not trade with the world to the extent it does today. In 1970, imports and exports together made up only 12 percent of our gross domestic product. By the mid-2000s they made up 24 percent.6

  The continuous move since World War II toward freer trade is a major reason that the United States has, over the past three decades, experienced a historic rise in its standard of living. Thanks to free trade, Americans of all income levels are now able to afford products from televisions to refrigerators to clothing that were once many times more expensive or considered luxuries.

  But the benefits of trade with other nations go far beyond being able to afford “cheap” TVs, clothes, and toys. By making the iPod affordable, low-cost flash chips from South Korea, for example, have helped to make possible an entirely new mini-industry, along with tens of thousands of jobs. Economist Ana Isabel Eiras of the Heritage Foundation writes:

  Specialization and free trade allow the U.S. to become more competitive and innovative. Innovation constantly provides new technologies that allow Americans to produce more, cure more diseases, pollute less, improve education, and choose from a greater range of investment opportunities. The resulting economic growth generates better-paying jobs, higher standards of living, and a greater appreciation of the benefits of living in a peaceful society.7

  Anyone who doubts the connection between free trade and innovation should look at the products of countries that don’t allow competition from imported products. A well-known example is the Trabant, the auto produced in East Germany, where it faced no competition. Little wonder it became known for shoddy quality.

  Anti-free traders, particularly organized labor, have bemoaned job loss resulting from corporations “outsourcing” or “offshoring”—using the lower-cost labor of other nations to manufacture goods once made in the United States. We’ve already noted that unemployment over the past three decades has been lower than when trade barriers were higher. And the trade bashers conveniently ignore the fact that foreign trade creates factory jobs in the United States. One out of every five American factory jobs is foreign trade related. Free trade also provides new markets for U.S. farmers, who export one-third of their crops.

  Free trade has raised living standards around the globe. As Robyn Meredith and Suzanne Hoppough wrote in Forbes in 2007, “globalization”—international free trade—has done more to help the people in Asia and Africa than the $2 trillion of foreign aid that the United States and Europe have poured into those regions in the last half century.8According to the International Monetary Fund, some two hundred million people have been lifted out of poverty since globalization took off in the 1990s.

  A study by the management consulting firm A. T. Kearney found that between 1980 and 1990 alone, global poverty rates fell by half—from 34 percent to 17 percent.9 Within that decade, trade helped to lift 573 million people above the absolute poverty line. The middle class, meanwhile, saw its median income worldwide rise by roughly 15 percent.

  Not only does free trade bring greater prosperity, but it also helps to usher in democracy—or the beginnings of it—to once-repressive dictatorships. No one would call China a democracy. But thanks to free trade and a more liberalized economy, that nation is nowhere near as oppressive as it was in the era of the Cultural Revolution under Mao Tse-tung. Daniel Griswold of the Cato Institute believes that the rise in global trade is related to the reduction of major armed conflicts. He cites a 2006 survey by the Stockholm International Peace Research Institute finding that since the early 1990s, “ongoing conflicts have dropped from 33 to 17, with all of them now civil conflicts within countries.”10 The reason?

  [D]emocracies tend not to pick fights with each other. Thanks in part to globalization, almost two thirds of the world’s countries today are democracies—a record high…. War in a globalized world not only means human casualties and bigger government, but also ruptured trade and investment ties that impose lasting damage on the economy. In short, globalization has dramatically raised the economic cost of war. 11

  Despite all the progress, free trade in the Real World is fragile. Protectionist pressures in all countries increase in hard times. During the 2004 presidential campaign, candidate John Kerry called companies that invested overseas “Benedict Arnolds.”12 Twenty years earlier, Walter Mondale raised the specter of America’s becoming a “hollowed-out” nation of “hamburger flippers” because of the rise of Germany and Japan. Even in the last campaign, Hillary Clinton and
Barack Obama competed with each other in denouncing the North American Free Trade Agreement.

  Opponents of “globalization” fan the flames of fear by raising the specter of all sorts of doomsday scenarios. None have ever come to pass. Former Michigan governor John Engler, president of the National Association of Manufacturers, points this out.

  The United States remains the world’s largest manufacturing nation, accounting for more than 19.5% of global manufacturing output. In 2007, the U.S. produced more volume of products than ever before, and manufacturing represented $1.6 trillion of our economy, or about 11.6% of gross domestic product.

  Manufacturing in the United States accounts for more than 12 million jobs and supports millions more in other sectors. And manufacturing jobs are among the most highly compensated in the nation, paying on average about 20% more than those in other sectors.13

  The real doomsday scenario would occur if trade were halted. The world economy would shut down.

  Q BUT ISN’T IT NECESSARY TO PRESERVE AMERICAN JOBS IN TOUGH ECONOMIC TIMES?

  A PROTECTIONISM DESTROYS FAR MORE JOBS THAN IT SAVES.

  The temptation for nations to turn inward inevitably grows in a down economy. Businesses and labor groups ramp up political pressure on legislators to eliminate foreign competition and—they think—save jobs. Hudson Institute trade policy analyst Rod Hunter reported that countries struggling with a worldwide recession in 2009 increasingly threw up trade barriers.

  World Bank staff report that G20 countries have implemented a raft of trade distorting measures since November [2008]—in many cases without violating their WTO commitments. Developing countries such as Ecuador and India have hiked up tariffs. Some have erected non-tariff barriers, sometimes camouflaged as consumer protection. China has banned Belgian chocolates, Irish pork, Italian brandy and Dutch eggs, and India has banned Chinese toys. 14

  The United States has shown similar protectionist impulses. In early 2009, the new Obama administration, in a political payoff to the Teamsters union, halted a program that had allowed about one hundred Mexican trucks access to U.S. roads. Meanwhile, stimulus legislation passed by the U.S. Congress featured a “Buy American” provision requiring that iron, steel, and manufactured goods acquired for infrastructure projects be produced in the United States.

  Whether it is banning Belgian chocolates or foreign steel or Mexican trucks, protectionism is never a solution to hard times. The Real World fact of the matter is—and this is something that emotional freetrade bashers often don’t get—even moderate-sounding trade protections can be extremely damaging. And they really don’t create many jobs; in fact, they destroy more than they save.

  “Buy American” is a case in point. To some, the patriotically named measure may not sound particularly threatening. What’s wrong with requiring that government projects use materials fabricated at home? Buy American, after all, is not an across-the-board tariff like the infamous Smoot-Hawley.

  Economists Gary Clyde Hufbauer and Jeffrey J. Schott of the Peterson Institute for International Economics calculate that the number of jobs that would be created by both the House and Senate versions of Buy American would be minimal. The original Buy American provisions as passed by the House of Representatives would have resulted in the purchase of about 0.5 million metric tons of steel—creating about one thousand domestic jobs. In a labor force of 140 million people, this number is—as the authors put it—barely a “rounding error.” They calculated that the total number of jobs created by the Senate version of the bill would be approximately nine thousand. 15

  Meanwhile, tens of thousands more jobs—directly and indirectly—would potentially be destroyed. Remember the classic case of Smoot-Hawley. That law was originally designed to help protect American farmers—and later, manufacturers and producers—from Canadian and other foreign competition. Yet within eighteen months of its enactment, unemployment had quadrupled.

  Buy American provisions also promote unemployment by soaking up private-sector capital that would have created jobs elsewhere in the economy. Dartmouth economics professor Douglas Irwin describes the capital destruction that took place in the 1990s as a result of California regulations requiring the San Francisco-Oakland Bay Bridge to use more costly domestic steel.

  Because of the large amount of steel used in the project, California taxpayers had to pay a whopping $400 million more for the bridge. While this is a windfall for a lucky steel company, steel production is capital intensive, and the rule makes less money available for other construction projects that can employ many more workers. 16

  Then there’s the job destruction that occurs when America’s trading partners retaliate. According to Hufbauer and Schott of the Peterson Institute, Buy American as originally written could have provoked retaliation by any of twelve foreign nations that are U.S. trading partners—a group that includes Canada, the UK, Japan, and Germany, as well as China, South Korea, and Hong Kong. Based on our level of exports to those countries, the economists estimated that if “10 percent of those exports are lost, as many as 65,000 jobs could vanish.”17 They conclude:

  The negative job impact of foreign retaliation against Buy American provisions could easily outweigh the positive effect of the measures on jobs in the U.S. iron and steel sector and other industries. The difference is that jobs lost would be spread across the entire manufacturing sector, while jobs gained would be concentrated in iron and steel and a few other industries. 18

  Fortunately, Buy American was eventually watered down after free traders protested that the provision violated existing trade agreements. Language was added that effectively neutralized the measure. However, the other protectionist move, the banning of one hundred Mexican trucks, resulted in Mexico slapping some $2.4 billion in tariffs on some ninety American products, from toilet paper and Christmas trees to fruit juices and deodorant. James Roberts of the Heritage Foundation writes that in Oregon alone, the tariffs will cost companies tens of millions of dollars, including $80 million in annual exports of french fries to Mexico. Canada, which doesn’t have to pay the tax, would pick up the business.19

  Bottom line: “protectionism” is really a euphemism for political favoritism that protects the jobs of a few at the expense of everyone else.

  REAL WORLD LESSON

  Buy American and other protectionist provisions kill future job creation, raise costs, and hobble growth, hurting many more people than they help.

  Q BUT DOESN’T OUTSOURCING OF JOBS OVERSEAS TAKE WORK FROM AMERICANS?

  A ONLY A SMALL PERCENTAGE OF JOBS ARE DIRECTLY LOST DUE TO OUTSOURCING. AND, IN THE LARGER ECONOMY, MORE ARE ACTUALLY GAINED THAN LOST.

  Everyone from Barack Obama to Pat Buchanan has assailed companies for “shipping jobs overseas.” Such heated characterizations may win votes and viewing audiences. But they are misguided. As we note in the introduction to this chapter, America is still the world’s largest manufacturer. In fact, relatively few jobs in the Real World U.S. economy are lost because of “outsourcing” or “offshoring.”

  According to a report by Forrester Research, not even 1 percent of jobs lost every quarter between 2000 and 2015 will likely be due to outsourcing. Contrary to popular perceptions, most American jobs can’t be outsourced. A report by the McKinsey Global Institute pointed this out in 2003,

  [T]he evidence available …suggests that fears about job losses … tend to overplay the likely impact of offshoring. The vast majority—some 70 percent—of the economy is composed of services such as retail, restaurants and hotels, personal care services, and the like spanning very broad wage and value added ranges. These services are necessarily produced and consumed locally—and therefore cannot be offshored. 20

  Much of the job loss blamed on “outsourcing” is actually part of the normal “churn,” the ongoing process of job loss and new-job creation that takes place as the economy changes and grows. Even China, with its robust growth, has lost manufacturing jobs—including fifteen million between 1995 and 2002, accord
ing to the Conference Board.

  What has really happened, as we explained earlier, is that jobs have shifted from one section of the economy to another, as America has increasingly become an economy specializing in services such as health care. This process is in fact helping our economy build wealth.

  Outsourcing jobs overseas also helps create extremely lucrative markets for the products and expertise that drive our economy. Foreign companies buy our telecommunications equipment, computer hardware, and software. According to McKinsey, every dollar spent by American companies abroad generates additional revenue for the United States. They conclude that “far from being bad for the United States, offshoring creates net additional value for the U.S. economy that did not exist before.”21

  A Real World economic truth conveniently overlooked by outsourcing opponents: the United States is a major exporter of services. According to the American Enterprise Institute, American services provided to other nations represent about a fifth of the global trade in services and about 30 percent of U.S. exports. For those who care about trade deficits (and as we explain later, you shouldn’t), our service economy is one place where we have had a trade surplus.

  The most visible benefit of outsourcing is, of course, the production of cheaper goods for Americans and people around the world. Outsourcing in the tech sector, for example, helped reduce the cost of computer components by 10 percent to 30 percent between 1995 and 2002, according to Catherine Mann of the Peterson Institute for International Economics.22These declines help explain why laptops can now be bought for as little as five hundred dollars at the local Best Buy.