Commentary Type

The Truth about Trade Agreements—and Why We Need Them

Chad P. Bown (PIIE)


US trade agreements could be the first economic casualty of the 2016 election. One of President-elect Donald Trump's signature campaign promises was to renegotiate the North American Free Trade Agreement (NAFTA) and even potentially pull the United States out of the World Trade Organization (WTO). And as Democratic leaders now contemplate their party's future, they, too, are questioning the wisdom of such international deals.

Existing US trade agreements rose from the ashes of World War II and the Great Depression. Understanding how they protect the US economy, American workers, and consumers is critical to avoiding a repeat of the policy mistakes of the 1930s.

International trade problems are separate from trade agreement problems

The recent pace of globalization has led to disheartening job loss for some Americans, especially in certain communities that backed Mr. Trump in the election. While imports and exports indisputably contribute big gains to the US economy overall, those resulting benefits have not been adequately shared.

Even the largest estimates find international trade has caused only a fraction of the US economic dislocation—including that likely suffered by Trump's key voters.

Rigorous economic research shows that these hardships are more than just anecdotal, one-off stories. But even the largest estimates find international trade has caused only a fraction of the US economic dislocation—including that likely suffered by Mr. Trump's key voters. Recognized studies led by economists David Autor, David Dorn, and Gordon Hanson observe that the surge in imports from China is an important contributor to US unemployment, for example, but it is responsible for less than 20 percent of the manufacturing job loss from 1999 to 2011. The other 80 percent of lost jobs were caused by something else entirely.

Automation eliminated many routine blue-collar jobs. Americans have also begun to demand new goods, including cleaner energy, thereby shunning old standbys like coal. And after the financial crisis of 2007, the US housing boom ended, wiping out construction jobs. There was a tsunami of change, and it attacked the livelihood of a concentrated set of US workers and communities.

Suddenly, a nimbler US workforce was required, one that was more adept at engaging with the increasingly skill-intensive, computerized, and service-oriented economy. The United States must now address two separate needs: It must help the currently displaced US workers while preparing the broader US labor force for the inevitable waves of change still to come.

But solutions will not be found in any trade agreement. Nor should they, as that is not what trade agreements do.

Trade agreements address a separate problem

Today's trade agreements arose as a reaction to the catastrophic government policies taken in response to the crisis of the 1930s. The US stock market crashed in October 1929, and the American economy stumbled into the Great Depression. The unemployment rate began a steady upward climb and ultimately peaked at 25 percent in 1933. US unemployment did not fall below 10 percent again for almost a decade, when the United States entered World War II.

In 1930, US politicians implemented the infamous Smoot-Hawley tariffs, first attempting to use trade policy to assist Americans in need. By forcing US consumers to buy American-produced and farmed goods instead of those from foreign countries, their hope was to shift demand and generate some additional tax revenue.

The US policy experience of the 1930s pales in comparison to how the United States handled the global financial crisis of 2008 and 2009. In 1930, the US government could have responded with fiscal stimulus—of new "shovel ready" government spending projects—like the Obama administration did through the American Recovery and Reinvestment Act of 2009. In 1930, the US government could have responded with monetary stimulus, like the US Federal Reserve did through interest rate cuts and quantitative easing during the Great Recession.

In 1930, the US government did not choose either policy and went with tariffs instead. Modern trade agreements that might halt this from happening did not yet exist in 1930. The United States put off implementing the right policies, especially in the face of deflation and falling prices, for far too long.

While the tariffs did not cause the Great Depression, they are now understood as being the wrong government response to fixing it. Tariffs attempt to address such a problem by pushing the policy's costs onto foreigners, by reducing their sales and the price they receive for the goods that they export to the United States.

And the foreign response to the 1930 Smoot-Hawley tariffs, in this light, became understandable. Since the United States had attempted to shift the burden of its crisis onto foreigners, they had little choice but to reciprocate by attempting to do the same thing. Their retaliatory trade policies further reduced US exports, and the recessionary decrease in worldwide demand meant a downward spiral of global trade.

In the end, no 1930s government was successful at passing along the costs of its crisis-era policies onto any foreigners.

Following World War II, the United States and 22 other countries finally rectified their mistakes by coming together to design the General Agreement on Tariffs and Trade. They negotiated basic rules for a trading system that would halt future governments from foolishly responding to economic panic by giving into the temptation to impose beggar-thy-neighbor policies. This system lives on today through the World Trade Organization, the institutional successor that took root in 1995.

Trade agreements do not prevent the US government from implementing needed domestic policies

Before the Obama administration entered office in 2009, most American workers were forced to rely exclusively on employer-provided health insurance. This made it more difficult for a worker to seek out a new job, and it also made involuntary job loss of any kind more disruptive.

The 2010 Affordable Care Act was the largest expansion of the US social safety net in decades, and informed trade proponents hold it up as reducing one important impediment to worker mobility.

The 2010 Affordable Care Act (ACA) was the largest expansion of the US social safety net in decades, and informed trade proponents hold it up as reducing one important impediment to worker mobility. Obamacare was a long overdue policy that supported the 21st century economy by making the US labor market more responsive to all forces of change.

Importantly, neither trade nor trade agreements impeded the ACA from coming into law in 2010.

The only role of the trade agreement was to compel the writers of Obamacare to think twice about how—and not whether—they were structuring the policy. Trade agreements force policymakers to confront the rhetorical question: Are we willing to bear the full financial and efficiency cost burden of the policy?

The trade agreement comes into play only if policymakers are implementing the policy because they think they can push its costs onto foreigners.

The job of the government's trade lawyer, the US Trade Representative, is to advise senior US officials that a failure to take this cost-shifting into consideration will have economic consequences. In internal meetings, the US Trade Representative will point out that additional costs will arise. They include the lost US exports and jobs that result when trading partners receive legal permission to retaliate, because the United States has broken the trade agreement's rules.

Trade agreements can therefore impose a check on US legislators and regulators, but only by forcing them to structure their policy so that it does not have a discriminatory impact on activity taking place outside of US borders. This will be the job of the US Trade Representative under the new administration as well.

But again, trade agreements are needed, because they reciprocally protect US-based exporting companies and their workers from foreign policymakers who would otherwise do the same thing.

It matters how trade agreements are enforced

Trade agreements are a voluntary form of international cooperation. If successful, they develop a world characterized by the rule of law. By itself, the rule of law is not enough. Laws can be written to protect the powerful at the expense of the weak. Laws can enshrine discrimination as opposed to equal opportunity. Even progressive laws can be neutered without enforcement.

It matters how each US administration chooses to enforce trade agreement violations. With limited budgets, the Trump administration must decide between which potential disputes to pursue.

Most US disputes follow a basic template: The US Trade Representative works on behalf of an American company and its workers that are seeking to open or re-open a foreign market to sell its goods or services.

Nevertheless, the difference in how the last two US administrations have prioritized their enforcement resources is telling.

The strategy of the George W. Bush administration was to focus enforcement resources on older and more mature markets, filing nearly half of its WTO disputes against Canada, the European Union, and Japan. While important economic markets for US exporters and workers, these were slower-growing and already relatively law-abiding economies.

The Bush administration was also quite slow to build a pipeline of WTO enforcement cases against China. Despite China's ever-growing economic importance, the country's continued lack of transparency, and US concerns that China's undervalued currency unfairly promoted Chinese exports, the first US-initiated dispute to reach a legal ruling arrived only in 2008. This was nearly seven full years after China's permitted entry into the WTO.

Quite differently, the Obama administration fought all its trade disputes against either China or some other emerging economy. These disputes are in line with the broader "pivot to Asia" that has sought expansion of American influence and economic opportunity in a fast-growing but underrepresented region. By picking these trading partners, the administration is enforcing the rights of US workers and companies to sell in relatively new and important markets of the future, where the rule of law has lagged.

Recent WTO cases have been brought on behalf of US farmers and auto and steel companies while also pushing the interests of US advanced manufacturing and clean energy industries.

And in a groundbreaking case against Guatemala, the Obama administration used a separate trade agreement to file the first-ever formal US legal challenge to the working conditions and labor standards of another country. The commitment to enforce higher labor standards abroad was important as the administration was simultaneously seeking to extend such standards, including to the NAFTA countries, through the new Trans-Pacific Partnership (TPP) agreement it was negotiating with 11 other nations.

Trade agreements do not prevent governments from directly helping address dislocated workers

As President-elect Trump gets ready to enter office, many aspects of the US job market show signs of improvement. At 5 percent, US unemployment is less than half the Great Recession peak reached in 2009. Out of a US labor force of 160 million, relatively few people that have been actively searching for a job are now unable to find one.

The more acute problem is the steadily increasing number of working-age American men without a college education who have stopped looking for employment and who thus do not show up in the unemployment statistics. Some have transitioned off the rolls of unemployment insurance to receive benefits under the government's disability insurance program. Some no longer receive any benefits at all. Too many are now on the outside of the US economy looking in, and this hurts them, their families, and their communities.

The more acute problem is the steadily increasing number of working-age American men without a college education who have stopped looking for employment and who thus do not show up in unemployment statistics.

Nothing in US trade agreements prevents fixing the US social safety net to better assist those disadvantaged by automation, changes in the types of goods and services that the global economy now demands or even trade.

Indeed, the Affordable Care Act of 2010 was one important step in this direction. Obamacare made health insurance portable for workers, even in the event of job loss. Repealing it would introduce a new source of economic uncertainty for millions of already anxious Americans.

Other improvements to the responsiveness of the US labor market are needed. Expanded educational opportunities, such as apprenticeship and employer-subsidized training programs, are important for continued maintenance and skill-building for the US workforce.

The existing Earned Income Tax Credit program tops up the wages of low-income household in the workforce. However, its current coverage is limited by design; expanding coverage would help advance the prospects of the working poor.

Wage insurance programs have been long proposed to assist displaced workers who are willing to transition to new employment that pays less than what they earned at their lost job. Dropping out for most any reason quickly leads to a decline in health outcomes and the costly atrophy of workplace skills. Making these programs available to all displaced workers—and not just those displaced by globalization—is important and would also incentivize remaining in the workforce.

Finally, it is also critical that the new administration and Congress make good on promises to fund needed investment in America's decaying infrastructure. President Obama's efforts were stymied during much of the last eight years; such investments are needed to raise productivity for the overall economy through easing the movement of workers, goods, and services within the United States. A focus on smart public construction, maintenance, and repair would also temporarily address the surfeit of non-college educated, working-age men who are currently on the outside looking in.

Don't renege. Renegotiate trade agreements

Trade does not only benefit the titans of global corporations. An estimated 11.5 million jobs in the United States are supported by exporting companies, and they pass along substantial benefits of globalization to their workers. For example, wages are 18 percent higher at these firms relative to all others in the US economy.

A US withdrawal from NAFTA or the WTO would lead to Mexico or other trading partners' retaliation—as witnessed in the 1930s—and likely a sharp fall in US exports. A new category of American workers at exporting companies would join those already suffering. And none of the existing problems would be solved.

An estimated 11.5 million jobs in the United States are supported by exporting companies, and they pass along substantial benefits of globalization to their workers.

If the incoming administration is serious about renegotiating NAFTA, it would find it worthwhile to examine a few elements of the much-vilified Trans-Pacific Partnership. The TPP agreement—while now shelved by Congress—included efforts to help level the playing field for productive, albeit relatively costly, US workers.

The TPP's innovation was to require a trading partner like Mexico to also have laws—like those found in the United States—that establish the rights of local workers to unionize and bargain collectively. The TPP also required Mexico to pass legislation on safe working conditions and minimum wages and to end employment discrimination and forced labor. Similar requirements were written into the TPP on environmental standards.

Suppose Mexico did not live up to the deal. TPP would have granted the United States the legal right to impose higher tariffs without concern for retaliation. Raising the costs of locating one's business in Mexico would thus make investments on American soil more attractive. America's blue-collar workers would implicitly benefit from raising labor and environmental standards abroad.

Hopefully Mr. Trump and the new Congress will recognize the benefit of existing trade agreements and how these innovations and others provide important protections for both American workers and for the overall US economy.

Final lessons

Globalization has led to a larger and richer US economy. Trade is what makes it financially possible for the US government to have more resources to address these other problems. Paying for the needed investment in US workers, their communities, and infrastructure is feasible economically if the United States remains open.

Trade agreements remain critical because that beggar-thy-neighbor temptation for governments never goes away.

As the 1930s revealed, US trade agreements are mainly important because everyone—even Americans—are foreigners somewhere. For US companies and their workers in the 21st century economy, 95 percent of the world's potential customers continue to live outside of our borders.

Trade agreements remain critical because that beggar-thy-neighbor temptation for governments—in the United States, but especially elsewhere—never goes away.

And that temptation will surely resurface if the United States is the first to rip them up.

More From