What Does Free Trade Lead To?

I have been thinking a great deal lately about the issue of free trade; specifically how greatly the views of economists and the general public differ. I believe both groups get it wrong in some ways: Economists get free trade wrong by using a definition of free trade that lacks practical application. The general public, however, gets in what they believe free trade will necessary lead to.

Free Trade in Theory vs. Free Trade in Practice

A lot of the time the term free trade is thrown around without any definition of what the speaker means by free trade. I discussed this problem in Are Economists Unreasonable About Free Trade?:

"There is no such thing as a free trade agreement. As Landsburg has pointed out, a true free-trade agreement could be written on the back of a napkin - "We won't put quotas or tariffs on your products if you won't put quotas or tariffs on our products". But no trade agreement in the history of the world has been like that. Have any economists actually read the Canada - U.S. Free Trade Agreement? The thing runs 230 pages and contains a raft of exemptions and restrictions... trade between Canada and the U.S. is hardly free. The term managed trade agreement is more apt. So the big question must be "Is Trade between the U.S. and Canada freer than it was before the agreement?" It may or may not be, [a] study showed that the agreement had at best a modest impact on the economy of either country."

Because of this, I believe part of the confusion between economists and the general public stems from the fact that the two groups are talking about entirely different things. Economists typically are thinking of the theoretical napkin version of a free-trade agreement, whereas the general public think about the "free trade" that actually happens - where some sectors are protected under the agreement and the agreement sets up an uneven playing field between countries and between industries. I find the general public's definition a lot more useful.

Free Trade - A Race To The Bottom or The Top?

In the previous section I sided with the general public, so in this section I will side with the economists. The general public, on average, seems to believe that freer trade (of their definition) will necessary lead to a race to the bottom. That is, jobs will necessary flow from areas with stronger environmental and labor protections to jurisdictions with weaker ones, as Nathan Johnson described in Does Freer Trade Mean Lower Environmental Standards?:

"The aforementioned concerns are legitimate and theoretically sound. Firms want to produce where they have lower costs of production, and avoiding pollution reduction techniques is a cost saver. Domestically, producers could claim foreign production facilities and firms have an unfair advantage because of lower environmental standards, so business lobbies would pressure for lower domestic standards in an effort to stay "competitive" with goods produced abroad."

It is a legitimate fear. As my colleague Tony Frost likes to point out, if this is the case then we can never have high environmental standards everywhere. Although many environmental measures improve as countries get wealthier, some country will always be the poorest and thus have a comparative advantage in accepting highly polluting industries.

While we may have a race to the bottom, it need not necessarily be the case; in fact we could even have a race to the top in some measures. The argument for the race to the bottom is that, ceteris paribus, production will go to where costs are cheapest. Even if you accept that logic (and I certainly do not think it would apply in all instances), the definition is a little sloppy. What is more important is that the unit costs be the cheapest. There are two ways to lower unit costs - either produce the same amount of goods at a lower total cost or produce more goods at the same total cost; that is become more productive with the same resources. With this in mind, there are then two ways to lower unit costs - the first is through cost reductions (which may come from lowering environment or labor standards) but the second is through increases in productivity, which could come from anything from increased education to improved infrastructure. It is quite possible then that freer trade could cause a race to the top through attempts to raise productivity in an effort to lower unit costs.

Free Trade - Where To Go From Here

We have just scratched the surface of free trade and have only considered two of the issues. I do hope, though, that both sides will eventually come to an understanding on these two issues - economists will finally adopt a useful definition of "free trade" and the general public will see that free trade need not necessarily lead to a downward spiral in standards.

I would love to get your thoughts - you can post them at <a href="http://economics.about.com/b/2008/09/04/what-does-free-trade-lead-to.htm">this blog entry</a>.