Free Trade Doesn't Work

by Ian Fletcher

  Henry VII’s advisors got their economic ideas ultimately from the city-states of Renaissance Italy, where economics had been born as a component of Civic Humanism, their now-forgotten governing ideology.408 The name for this forgotten developmentalist wisdom of early modern Europe that has stuck is mercantilism. One of the great myths of contemporary economics is that mercantilism was an analytically vacuous bundle of gold-hoarding prejudices.409 It was, in fact, a remarkably sophisticated attempt, given the limited conceptual apparatus of the time, to advance national economic development by means that would be familiar and congenial to the technocrats of 21st-century Tokyo, Beijing, or Seoul.410

  Mercantilists invented many economic concepts still in use today, such as the balance of payments, value added, and the embodied labor content of imports and exports. They championed the economic interests of the nation as a whole at a time when special interests (notably royal monopolies) were an even bigger problem than today. They began with obvious ideas like taxing foreign luxury goods. They progressed to the idea that exporting raw materials for foreigners to process was bad if the nation could process them itself.411 They understood that nations rose economically by imitating the industries of already rich nations (first the more primitive industries, then the more sophisticated) and that low relative wages were the key advantage of underdeveloped nations in this game.

  Even mercantilists’ much-mocked obsession with the accumulation of bullion was not as irrational as it is usually depicted as being, given that under a monetary system based on gold, accumulating it is the only way to expand the money supply and drive down interest rates, a boon to investment then as now.412 Mercantilism, in fact, created the modern European economy and thus made possible the colonial power that economically shaped much of the rest of the world. It is thus the foundation of modern capitalism itself.

  Anyhow: Britain functioned on a mercantilist basis for centuries before its much misunderstood experiment with free trade began. Even as late as the beginning of the 19th century, Britain’s average tariff on manufactured goods was roughly 50 percent—the highest of any major nation in Europe.413 And even after Britain embraced free trade in most goods, it continued to tightly regulate trade in strategic capital goods, such as the machinery for the mass production of textiles, in order to forestall its rivals. As we saw in the previous chapter, this was rational, as the win-win logic of free trade can break down if factors of production are mobile between nations (dubious assumption #4) or if free trade induces adverse productivity growth abroad (dubious assumption #6).414 Even Adam Smith himself was only in favor of free trade after Britain had consolidated its industrial power through protectionism.415

  BRITAIN’S FREE TRADE GAMBLE

  Free trade in Britain began in earnest with the repeal of the Corn Laws in 1846, which amounted to free trade in food, Britain’s major import at the time. (“Corn,” in the usage of the day, meant all grains.) The general election of 1852 was taken for a plebiscite on the question,416 and free trade began inexorably to restructure the British economy from without.417 Repealing the Corn Laws was a momentous step because this removed the last major constraint on Britain’s transformation, along the lines of its then- comparative advantage in manufacturing, into the world’s first industrial society, where most workers would be factory workers, not farmers: how to feed so many factory workers?

  To some extent, the objective of the Corn Laws was simply to feed a bulge in population (almost a tripling in the previous 100 years) on a small island with limited agricultural potential.418 Competition with the prairies of North America eventually devastated Britain’s old rural economy and the aristocracy that had lived off its agricultural rents,419 but so committed was Britain to free trade that this price was accepted as in no other nation. Britain’s rulers expected that free trade would result in their country dominating the emerging global industrial economy due to its head start, sidelining its trading partners into agriculture and raw materials. They expected their lead in shipping, technology, scale economies, and financial infrastructure to be self-reinforcing and thus last indefinitely.420

  If the rest of the world had been content to be played for fools, this strategy might have worked. Instead, it enjoyed a brief window of plausibility in the 1850s and 1860s, which were the zenith of classical liberalism (of which free trade was a part) in Europe generally. Then things started to sour. For one thing, this zenith of free trade coincided with a prolonged Europe-wide depression, which started to lift as protectionism began to take hold.421 More fundamentally, the British plan for universal free trade stumbled as the U.S. and the rest of Europe declined to accept their inferior allotted roles in the global trading system. In Germany and the United States especially, people accused Britain of favoring free trade for other countries and only after having secured its own position through protectionism. The influential German economist Friedrich List (1789-1846) called this “kicking away the ladder.” As one British Lord said in Parliament:

  Other nations knew, as well the noble lord opposite, and those who acted with him, that what we meant by free trade, was nothing more nor less than, by means of the great advantages we enjoyed, to get the monopoly of all their markets for our manufactures, and to prevent them, one and all, from ever becoming manufacturing nations.422

  So despite British preaching, free trade was falling apart. Britain practiced it unilaterally in the vain hope of imitation, but the United States emerged from the Civil War even more explicitly protectionist than before, Germany under Bismarck turned in this direction in 1879, and the rest of Europe followed. During the 1880s and 1890s, tariffs went up in Sweden, Italy, France, Austria-Hungary, and Spain.423 There was good reason for this: they worked. A study by the Irish economist Kevin O’Rourke shows a clear correlation between protection and economic growth rates in Europe in the 1875-1914 period.424

  FOREIGN PROTECTIONISM, BRITISH DECLINE

  The United States brought to global competition continental economies of scale and a more aggressively commercial culture than Britain. Germany brought industrial paternalism that delivered an efficient workforce and a prescient understanding that science-based industry was the wave of the future—quintessentially in optics, chemical engineering, and the electrical industries. Both nations forged ahead under protectionism. Britain’s economy still grew, but inexorably lagged: from 1870 to 1913, industrial production rose an average of 4.7 percent per year in the U.S., 4.1 percent in Germany, but only 2.1 percent in Britain.425 In the melancholy words of one commentator:

  The industries that formed the core of the British economy in the 19th century, textiles and steel, were developed during the period 1750-1840—before England abandoned mercantilism. Britain’s lead in these fields held for roughly two decades after adopting free trade but eroded as other nations caught up. Britain then fell behind as new industries, using more advanced technology, emerged after 1870. These new industries were fostered by states that still practiced mercantilism, including protectionism.426

  But despite the mounting failure of its great strategic gamble, Britain stuck to free trade abroad and a laissez-faire absence of industrial policy at home. Fundamentally, the country was lulled by the Indian summer of its industrial supremacy—it was surpassed economically by the U.S. only around 1880—into thinking that free trade was optimal as a permanent policy. The clarity of British thinking was not helped by the fact that certain vested interests had fattened upon free trade and established a grip upon the levers of power that was hard to break.

  Britain’s decline did not go unnoticed at the time, either at home or abroad. Neither did the underlying problem: in the 1906 words of Member of Parliament F.E. Smith, later famous as a friend of Winston Churchill:

  We give to our rivals a free market of 43,000,000 persons in the United Kingdom to add to their own free market. Thus the United States possess an open market of 82,000,000 persons in the United States, plus an open market of 43,000,000 persons in Great Britain, making,
altogether, 125,000,000. Similarly, Germany possesses an open market of 43,000,000 in Great Britain. As against this, we possess only such residual of our open market of 43,000,000 as the unrestricted competition of foreign nations leaves unimpaired….We call ourselves free traders, but we have never secured free trade for ourselves; we have merely succeeded in enlarging the area within which our protectionist competitors enjoy free trade.427 (Emphasis added.)

  Some British politicians set out to do something about the problem. The great crusader to abolish free trade was the Conservative Parliamentarian Joseph Chamberlain (1836-1914), father of the more famous Neville.428 As he put it in a major speech in 1903:

  I believe that all this is part of the old fallacy about the transfer of employment...It is your fault if you do not leave the industry which is failing and join the industry which is rising. Well—sir, it is an admirable theory; it satisfies everything but an empty stomach. Look how easy it is. Your once great trade in sugar refining is gone; all right, try jam. Your iron trade is going; never mind, you can make mouse traps. The cotton trade is threatened; well, what does that matter to you? Suppose you tried dolls’ eyes...But how long is this to go on? Why on earth are you to suppose that the same process which ruined sugar refining will not in the course of time be applied to jam? And when jam is gone? Then you have to find something else. And believe me, that although the industries of this country are very various, you cannot go on forever. You cannot go on watching with indifference the disappearance of your principal industries.429

  The British turn-of-the-last-century debate eerily echoes the free trade debate in America today. It was an era like our own, with new technologies like the steamship and the telegraph ushering in fears of what a borderless global economy might bring. The political fate of a weakening superpower with global responsibilities was bound up in fears of its economic decline. Consider these familiar-sounding agenda items from a conference of Britain’s Trades Union Congress: “the need to deal with competition from the Asian colonies” and “the need to match the educational and training standards of the United States and Germany.”430

  The same accusations made in the U.S. today flew back and forth. Free traders were accused of viewing economics solely from the consumer’s point of view and of favoring short-term consumption over long-term producer vitality. Protectionist concern for producer vitality was tarred as mere cover for special interests. It was debated whether protectionism stifled competition by excluding foreigners or preserved it by saving domestic competitors (new trade theory now understands it can do either).431 It was debated whether the country was living off its past capital. It clearly was: by the late 19th century, Britain ran a chronic deficit in goods and only managed to balance its trade by exporting services as shipper and banker to the world and by collecting returns on past overseas investments. Free traders were accused of abstractionism; in the words of one book at the time:

  The free trader hardly professes to base his opinions on experience; he is content to adduce illustrations from actual life of what he believes must happen.432

  Those words could have been written yesterday! The trustworthiness of British economists, ideologically mortgaged to the free-trade tradition of classical political economy, was questioned. Free traders denied the existence of a crisis on the grounds that the nation’s sunrise industries were doing well (some were, but not enough to replace the sunset industries being lost). The two sides preened themselves on their cosmopolitanism and their patriotism, respectively.

  In hindsight, the protectionists had the stronger case, but were outfought by the superior rhetorical and political skill of their rivals. The vested interests and experienced political tacticians were mostly on the free-trade side—which included half of Chamberlain’s own Conservative party, which split on the question. Free traders were defending a status quo bound up in concepts of economic liberty believed essential to British national identity, concepts that struck at the heart of what made Britons different from statist Continental Europeans. And free trade’s opponents made no attack upon the economic theory behind free trade, beyond simply denying its effectiveness. This made it impossible for them to construct a case against free trade strong enough to pull it up by its roots.

  Chamberlain struggled to enact a tariff from 1903 to 1906, when his party fought a general election, largely on this very issue. The divided Conservatives lost to the free-trade Liberal party. Their next chance came in 1923 and they lost again, this time to the free-trade Labour party. Thanks to the Great Depression, Britain finally abandoned free trade in 1931—but by then it was too little, too late. Although protectionism buffered Britain against the Depression somewhat, it was far too late to redeem the nation’s position as a leading economic power. Today, outside the City of London’s financial center, the one-time Workshop of the World, which generated a third of global industrial production in 1870,433 is an economic asterisk.

  AMERICA, SWEET LAND OF PROTECTIONISM

  The idea that America’s economic tradition has been economic liberty, laissez faire, and wide-open cowboy capitalism—which would naturally include free trade—resonates well with our national mythology. It fits the image of this country held by both the Right (which celebrates this tradition) and the Left (which bemoans it). It is believed both here and abroad. But when it comes to trade at least, it is simply not real history. The reality is that all four presidents on Mount Rushmore were protectionists. (Even Jefferson came around after the War of 1812.)434 Protectionism is, in fact, the real American Way.

  Americans were alert to the dangers inherent in trade economics even before Independence. During the colonial period, the British government tried to force its American colonies to become suppliers of raw materials to the nascent British industrial machine while denying them any manufacturing industry of their own. The colonies were, in fact, one of the major victims of Britain’s previously-noted mercantilist policy, being under Britain’s direct political control, unlike its other trading partners. As former Prime Minster William Pitt, otherwise a famous conciliator of American grievances and the namesake of Pittsburgh, once said in Parliament, “If the Americans should manufacture a lock of wool or a horse shoe, I would fill their ports with ships and their towns with troops.”435

  To some extent, the American Revolution was, in fact, a war over industrial policy, in which the commercial elite of the Colonies revolted against being forced into an inferior role in the emerging Atlantic economy. This is one of the things that gave the American Revolution its exceptionally bourgeois character as revolutions go, with bewigged Founding Fathers rather than the usual unshaven revolutionary mobs. It is no accident that upon Independence, a tariff was the very second bill signed by President Washington.436

  Protectionism’s first American theorist was Alexander Hamilton—the man on the $10 bill, the first Treasury Secretary, and America’s first technocrat. As aide-de-camp to General Washington during the Revolution, he had seen the U.S. nearly lose due to lack of capacity to manufacture weapons (France rescued us with 80,000 muskets and other war materiel.) He worried that Britain’s lead in manufacturing would remain entrenched, condemning the United States to being a producer of agricultural products and raw materials. In modern terms, a banana republic. As he put it in 1791:

  The superiority antecedently enjoyed by nations who have preoccupied and perfected a branch of industry, constitutes a more formidable obstacle than either of those which have been mentioned, to the introduction of the same branch into a country in which it did not before exist. To maintain, between the recent establishments of one country, and the long-matured establishments of another country, a competition upon equal terms, both as to quality and price, is, in most cases, impracticable. The disparity, in the one, or in the other, or in both, must necessarily be so considerable, as to forbid a successful rivalship, without the extraordinary aid and protection of government.437

  Hamilton’s policies came down to about a dozen key measures. In h
is own words:438

  1. “Protecting duties.” (Tariffs.)

  2. “Prohibition of rival articles or duties equivalent to prohibitions.” .(Outright import bans.)

  3. “Prohibition of the exportation of the materials of manufactures.” (Export bans on industrial inputs, like King Henry VII’s ban on exporting raw wool.)

  4. “Pecuniary bounties.” (Export subsidies, like those provided today .by the Export-Import Bank and other programs.)

  5. “Premiums.” (Subsidies for key innovations. Today, we would call them research and development tax credits.)

  6. “The exemption of the materials of manufactures from duty.” (Import liberalization for industrial inputs, so some other country can be the raw materials exporter.)

  7. “Drawbacks of the duties which are imposed on the materials of manufactures.” (Same idea, by means of tax rebates.)

  8. “The encouragement of new inventions and discoveries at home, and of the introduction into the United States of such as may have been made in other countries; particularly those, which relate to .machinery.” (Prizes for inventions and, more importantly, patents.)

  9. “Judicious regulations for the inspection of manufactured commodities.” (Regulation of product standards, as the USDA and .FDA do today.)

  10. “The facilitating of pecuniary remittances from place to place.” .(A sophisticated financial system.)