It’s the Free Trade, Stupid

Published on Global, by Ian Fletcher, August 11, 2011.

One point that seems largely to have been missed in recent weeks, amid all the excitement over the Federal budget and the sovereign-debt crises in Europe, is how free trade is largely the root cause of all these problems. Let’s trace the causation for a minute.

Start with the Federal budget. Federal revenues are derived from the underlying economy, and therefore, if the underlying economy were larger, revenues would be, too—even without any tax increases. As a result, anything that causes the U.S. economy to be smaller, tends to widen any gap between taxes and revenues.

Enter free trade: 

For it is thanks to America’s embrace of free trade (whether genuinely free or not, that’s another issue) that we have been running giant trade deficits for years. And these have been costing us economic growth.

The Economic Strategy Institute, a Washington think tank, estimated in 2001 that the trade deficit was shaving at least one percent per year off our economic growth. (See the report China’s Financial System and Monetary Policies: The Impact on U.S. Exchange Rates, Capital Markets, and Interest Rates, 117 pdf-pages, U.S.-China Economic and Security Review Commission, August 22, 2006, for the gory details.) This may not sound like much, but because GDP growth is cumulative, it compounds over time.  Economist William Bahr has thus estimated that America’s trade deficits since 1991 alone—they stretch back unbroken to 1976—have caused our economy to be 13 percent smaller than it otherwise would be.

That’s an economic hole larger than the entire Canadian economy … //

… The above analysis holds, in slightly different form, in Europe.  Nations like Greece, Portugal, Italy, and Spain have also run chronic trade deficits for years. As in our own case, their deficits were bridged by foreign credit—largely from Greater Germany (Germany, Austria, Switzerland, Denmark, Finland, Sweden, and Holland).

As in our own case, the willingness of foreigners to lend them money was politically inflated—in their case by the replacement of national currencies by the euro, which enabled un-creditworthy governments like Greece to borrow on terms similar to those of creditworthy governments like Germany.

Because these European nations have smaller and weaker economies than the U.S., and because they borrowed in a currency which (unlike our own situation with the dollar) they cannot print, the inevitable long-term consequences hit them first. But we’re not going to be exempt forever.

The underlying lesson is the same in our case and theirs: free trade causes trade deficits and therefore debt.  The free market, on its own, will neither limit the accumulation of excessive debt nor redress the excess once it has been created. Government is eventually forced to step in, to solve a crisis it could have largely avoided if it had not embraced free trade in the first place … (full text).

Ian Fletcher is the author of Free Trade Doesn’t Work: What Should Replace It and Why.


Ian Fletcher’s personal website;

Ian Fletcher Battlefield Tours;

The Indian Economy Review 2011, Volume VII, quarterly Issue, January 1, 2011, ISSN 2229-2004, or as pdf online here … it’s Editorial: the first word and the last word, US Jails better than Indian Homes, on page 5/192 (found via IIPM THINK TANK, August 15, 2011 /click on file-name).

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