Free Trade Agreements- Helpful or Harmful to American Businesses
By Edward G. Thomas, NCBFAA 2005 Scholarship Winner

 

Harry S. Truman was very perceptive when he joked, "Give me a one-handed economist! All economists say, ‘On the one hand . . . on other hand’." Rarely when a simple question is asked to an economist is a simple answer given. This holds true in the area of free trade agreements. Since tariff prices are dropped to zero for member countries, with external tariffs towards non-member countries remaining, some economists argue that this preferential arrangement may create overall damage to the economy.

 

Of course, other economists believe that any increase in free trade must be beneficial to the economy. However, because the question of free trade agreements is directed specifically at its effects on American businesses, a "one handed" answer can be given. American businesses will benefit from free trade agreements for two specific reasons. American businesses are consumers too, to quote Douglas Irwin’s1, and the magnitude of America’s economy permits an excellent position in the negotiating of free trade agreements.

 

Often the main argument opposing free trade agreements is its destruction of American jobs. Many will remember Ross Perot’s sucking sound as American jobs were sucked to Mexico by NAFTA. History, economic literature, and the real world all maintain strong examples why this is not the case with free trade agreements. The strongest case supporting free trades’ effect on jobs hinges on reality by understanding that businesses are consumers too. First, however, what do history and economic literature express on the matter?

 

The United States has had a positive experience with free trade agreements in its recent history. After NAFTA was put into effect in 1994, the U.S. experienced a time of unprecedented growth. Unemployment rates hovered near record lows for the second half of the decade. While no economist or businessman would attribute these gains solely to NAFTA, it is far from the view expressed by nay-saying economists and presidential candidates.

 

Economic literature informs us that employment is to be viewed as a macroeconomic phenomenon. Any macroeconomic textbook will teach that employment in the short run depends upon the aggregate level of demand and in the long run the natural rate of unemployment. Microeconomic policies, such as tariffs or tariff reduction, will have little net effect on employment levels2. The key term, however, is net effect. Free trade wilt cause individual groups to be helped or hurt, but the net effect on employment will be neutral.

 

The Heckscher-Ohlin model, an economic tool used to evaluate gains from trade, expresses exactly that occurrence. The model relates that owners of a country’s abundant resources gain, owners of a country’s scarce resources lose, and the economy as a whole is unambiguously better off from trade3. This means the exporting industries are better off, the importing industry are worse off, and consumers benefit as a group. How then is this shown in the real world as it applies to American businesses, since we assume import intensive industries will be hurt?

 

Strong factions exist to lobby for protection in Washington against free trade and flee trade agreements. It may make intuitive sense that protecting import sensitive industries will save American jobs and help American businesses, but fits is far from the case. Downstream industries reliant on the importation of raw materials from abroad suffer when free trade breaks downs. Businesses are a bigger consumer of imported goods, in real terms, than are U.S. households. As high as 60 percent of U.S. imports are immediate components or raw materials that are used in production, not final consumer goods4. A lack of free trade will have a detrimental effect on a firm’s production cost and competitiveness.

 

The steel industry is an excellent example. While the steel tariffs used recently or the voluntary restraint agreements used in the 1980’s may be beneficial to the concentrated group of steel workers and factory owners, they hurt industries using steel as a main input. Firms such as the automobile industry and others manufacturing heavy equipment will be subjected to rising steel prices. ThSe price incrpases make them less competitive domestically and in foreign markets. Such a price increase will adversely affect such business’s production, employment, and sales volume because their product will nowbe more expensive to produce and sell. Some firms may even be forced abroad in order to remain competitive by having access to freely traded, hence cheaper, goods.

 

A lack of free trade on sugar, while less publicly acknowledged, offers an excellent example of such a firm. The United States has maintained tight quotas on sugar imports causing the domestic price to be up to two and three times higher than the world price. While each consumer paying a few dollars more a year per bag seems like a small price to pay for the protection of the U.S. sugar farmers, businesses are consumers too.

 

This few dollars more a bag calculates into a large sum if a business produces sugar intensive products. The U.S. Department of Commerce estimates that almost 9,000 jobs were lost in the mid 1980’s due to high sugar prices. Sugar intensive industries must pay these higher prices and become less competitive against foreign imports and domestic substitutes resulting in layoffs or firm relocations. The Brachs Candy Company of Chicago announced that it would close its factory in Chicago and relocate to Canada, taking with it 3,000 jobs, to take advantage of the cheaper, tariff free, sugar imports5. American businesses certainly would have been better served with free trade.

 

A lack of free trade also effects downstream production in the technology sector. It was common in the mid 1980s for the U.S. to use antidumping agreements to slow the flow of Japanese memory chips and flat panels into U.S. markets6. Many technology-producing firms such as IBM, Tandem, and Hewlett-Packard, formed the Computer Systems Policy Project to oppose the powers lobbying against free trade. These firms complained, and justifiably so, that they could not compete with Asian firms who had access to much lower prices for necessary inputs. They stated that without a return to free trade and access to the world market prices they would have to shift production overseas to remain competitive both domestically and abroad.

 

Such examples, along with the historical and economic evidence, strongly suggest that free trade agreements will be helpful to American businesses. The above examples may hold true for most countries, but America has another advantage iii its gain from free trade agreements. The size of its’ economy gives it a strong bargaining position at the free trade negotiating table. Smaller countries will often make greater concessions in order to gain access to the U.S. market.

 

The 2004 failure of the Cancun round of the WTO, in large part, stemmed from many of the developing countries of the world binding together to call for a reduction in agricultural tariffs and subsidies by the U.S. and the EU. Despite the break down of these talks, the U.S. has been able to complete successful bilateral trade talks with other South and Central American countries that will open their markets to the U.S. in spite of the United States unwillingness to remove many of the farm subsidies that were central in the Cancun round.

 

The U.S. was able to get concessions on property protection, environmental and labor standard harmonization, and intellectual property rights protection by negotiating one-on-one with Mexico7. Such concessions would not be reached if it were not for the magnitude and opportunity inherent in access to the U.S. market. Even as Chile was opposed to such conditions during the Cancun round, they now appear willing to accept such conditions based upon the bilateral discussions taking place to lay the ground work for the Free Trade Area of the Americas.

 

Similarly, the U.S. was able to use its economic size and Canada’s growing dependence on U.S. markets to negotiate a more beneficial agreement for U.S. businesses in the Canada United States Free Trade Area. The U.S. had less interest in a free trade agreement, as they had less at stake, so it is generally observed that Canada made most of the concessions. Canada gave up the practice of discriminatory oil pricing, and went so far as to commit to not withhold oil supplies in favor of domestic users8. Canada also agreed to expand intellectual property rights, which raised royalty payments to U.S. pharmaceutical firms.

 

With its size and strength, the U.S. is able to slcillfufly craft free trade area negotiations into molds that best suit U.S. businesses. While this may not be the most benevolent view of U.S. trade policy, it certainly answers what the effect free trade will be on American businesses. By making it necessary for foreign countries to harmonize many of their environmental, labor, and other standards into closer conformity with that of America, prior to free access to American markets, many businesses previously at a disadvantage will be without such handicaps. Many economists would hardily disagree citing that such a policy is far from universally optimal, but in this scenario it can be seen as being helpful to U.S. firms.

 

While certain factions of businesses and like-minded economists nay suggest that free trade areas can be harmful, it seems likely that as they apply to American businesses, they are helpful. When free trade areas allow for inputs in production to be at the lowest price, although some loses may occur, it will be beneficial. Downstream industries, when taken in the aggregate, will employ more American workers than industries competing against the raw materials being imported, such as steel, sugar, and computer parts. If prices rise due to a lack of free trade, then businesses as a whole are adversely affected. Coupled with the U.S. ability to negotiate optimal trade policies, free trade agreements are indeed helpful to U.S. businesses.

Footnotes

  • Douglas Irwin, Three S Principles of Trade Policy, Washington D.C.; American Enterprise Institute, 1996), pg. 10.
  • Paul Krugman, What do Undergrads Need to Know about Trade?, (Cambridge, American Economic Association, 1993), pg. 25.
  • Paul Krugman & Maurice Obstfeld, International Economics: Theory and Policy; Sixth Edition, (Addison Wesley, 2003), pg. 77.
  • Douglas Irwin, Three Simple Principles of Trade Policy, (Washington D.C.; American Enterprise Institute, 1996), pg. 14
  • Douglas Irwin, Three Simple Principles of Trade Policy, (Washington D.C.; American Enterprise Institute, 1996), pg. 16
  • Douglas Irwin, Three Simple Principles of Trade Policy, (Washington D.C.; American Enterprise Institute, 1996), pg. 16
  • Jagdish Bhagwati & Arvind Panagariya, The Economics of Preferential Trade Areements. (washington, D.C; The AEI Press, 1996), pg. 51
  • John McLaren, (Size, Sunk Costs and Judge Bowk.er ‘s Objection to Free Trade. (The American Economic Review; 1997), pg. 405.

 

References

  • Bhagwati, Jagdisli & Panagariya Arvind. The Economics of Preferential Trade Agreements. Washington, D.C.; The AE Press, 1996
  • Irwin, Douglas. Three Simple Principles of Trade Policy, Washington D.C. American Enterprise Institute, 1996
  • Krugman, Paul. What do Undergrads Need to Know about Trade? Cambridge; American Economic Association, 1993
  • Krugman, Paul & Obstfeld, Maurice. International Economics: Theory and Policy; Sixth Edition. Addison Publishing, 2003
  • Krugman, Paul. The Economist November 13, 2003
  • McLaren, John. Size, Sunk Costs, and Judge Bowker‘s Objection to Free Trade. The American Economic Review. Vol. 87, No. 3 (June, 1997)
  • Bibliography
  • Bhagwati, Jagdish & Krueger, Anne. The Dangerous Drift to Preferential Trade Agreements. Washington, D.C.; The AE Press, 1995.
  • Deere, Carolyn & Esty, Daniel. Greening The Americas: NAFTA Lessons for Hemispheric Trade. Massachusetts; MIT Press, 2002.
  • Frankel, Jeffrey. Regional Trading Blocs: In the World Economic System. Washington D.C.; Institute for International Economics, 1997.
  • The World Bank. Global Economic Prospects: Trade, Regionalism, and Development Washington, D.C.; The International Bank for Reconstruction and Development/The World Bank, 2005.
  • Mikic, Mia. International Trade. New York; St. Martin’s Press, 1998.

 

 

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