Maybe We Can’t Afford Free Trade : Falling Dollar Fails to Deliver the Expected Turnaround

In recent weeks a burst of economic statistics has reconfirmed two increasingly perplexing and related developments. Economic growth continues to be weak despite low oil prices and falling interest rates, which, according to the conventional wisdom, should have stimulated economic activity. And trade deficits continue to set records despite a dramatic fall in the dollar over the past 17 months, which, again according to the conventional wisdom, should have produced a rise in exports and a fall in imports.

Is there something wrong with the conventional wisdom and, hence, with the conventional prescriptions?

If the devaluation of the dollar, which has been at the heart of President Reagan’s strategy to correct the trade deficit without recourse to protection, is not effective, then protectionist pressures will increase.

Indeed, increasing protectionist pressures in Congress as well as among businessmen, farmers and (according to most opinion polls) the general public reflect rising frustration with U.S. economic performance and the apparent unwillingness of other industrial countries to play by the same rules as we do. But the protectionism also reflects growing doubts about whether free trade is still the best way for the United States to maximize its national economic interests.

Part of the problem is that the world has changed. When the theory of free trade was promulgated, there were only a handful of industrial countries in competition with each other. Developing nations were mainly sources of raw materials. Control of international finance directly translated into control of international commerce. Technology flows among countries were limited. And economic dislocations caused by international trade typically meant that one region of a country would lose an industry to another region, rather than to another country.

Part of the problem is that the United States also has changed. In 1950 America dominated the world economy, setting the rules of international commerce, providing the finance to reconstruct Europe and Japan, and benefiting from the central role of the dollar. But trade accounted for only 8% of the gross domestic product, and a relatively small segment of the U.S. economy was actually exposed to international competition. In 1986 U.S. economic domination has faded, weak productivity growth has undermined our competitive position, and many countries have become capable of producing the kinds of high- and medium-technology goods that in earlier years would have been the preserve of only the most advanced nations. The export and import of goods and services now accounts for 23% of gross domestic product, while imports of manufactured goods are approaching 20% of the value of U.S. consumption of such products, compared to around 12% five years ago.

In short, as the importance of trade for the U.S. economy has increased, U.S. influence in international trade has declined. As a result, we are less able to set the rules of international commerce, while we are more exposed to the vagaries of the international environment. We are more and more the losers in the international trade game--especially since U.S. economic policy has failed to stimulate a sustained improvement in productivity or an increase in investment. We export and produce less and import more; inevitably, economic growth slows.

How do we escape from the vicious circle of poor growth and poor trade performance? Some analysts and some policy-makers suggest waiting: Eventually the old-time religion of a devalued dollar may work. Others insist that eventually the Japanese and the Europeans will bow to our pressure, opening their markets and stimulating their economies in ways that increase imports from the United States. And still others argue that the new multilateral-trade round will provide a forum to “level the playing field,” although the United States has yet to articulate specific goals or a coherent strategy for the negotiations.

But in case these do not work, or if the cost of waiting for them to become effective is too great, the alternative of new trading arrangements should be explored. Perhaps the United States, politically and economically, is no longer capable of supporting a more or less free trade system, as it has since the late 1940s. Perhaps our core commitments in the future should be bilateral instead of multilateral, to countries with economies complementary to ours that can offer reciprocal, immediate commercial benefits in return for access to the U.S. market. Perhaps there are industries that the United States cannot afford to lose, from either a national-security or an economic perspective. And perhaps the pace of economic dislocation resulting from America’s accelerating insertion into the world economy needs to be slowed and managed to protect our standard of living and to secure our economic future.

Admittedly, these are almost heretical thoughts for economists and policy-makers trained during the postwar years when economic prosperity and international trade went hand in hand. But heresy may be preferable to economic decline.