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The Benefits of Open Markets and The Cost of Trade Protection
And Economic Sanctions
American Council for Capital Formation
December 1997
By Gary C. Hufbauer*
*Summary of a paper by Gary C. Hufbauer, Maurice R. Greenberg Chair
and Director of Studies, Council on Foreign Relations. This paper was
prepared for a September 9, 1997 policy conference sponsored by the ACCF
Center for Policy Research, and will be published in the ACCF's forthcoming
book, Free Trade vs. Protectionism and Economic Sanctions: What
Are the Issues?
Executive Summary
The Administration's recent failure to persuade Congress to grant "fast
track" authority to negotiate trade agreements stems in part from
a lack of understanding of the benefits of free trade for all consumers
and for most workers. This study shows that free trade accelerates economic
growth and investment, raises real wages, and enhances productivity growth.
In addition, it shows that exposure to the world market has led to major
improvements across a range of U.S. industries. Productivity in American
plants that export is almost 40 percent higher on average for plants of
all sizes, locations, and industries than for plants that produce only
for the domestic U.S. market.
This study also concludes that economic sanctions-a tool used increasingly
by the U.S. government to punish a country for its political views and
actions by interfering with trade and foreign investment-usually do not
work. In 1995 alone, U.S. economic sanctions against other nations reduced
U.S. exports by up to $19 billion and deprived the U.S. economy of more
than 200,000 relatively high-wage jobs.
Background
In recent years there has been a clear and marked trend in all regions
of the world favoring the adoption of outwardly oriented economic policies.
These policies entail opening domestic markets to imports and foreign
investment and encouraging exports and investments overseas.
Outwardly oriented economic policies and globalization have combined in
mutually supportive ways. Internationalization of business activities
was made possible by two generations of trade and investment liberalization
under GATT and OECD auspices, and pushed by successive American presidents.
In turn, the desire of firms to have a global presence is the impetus
behind new governmental efforts to further open markets to international
competition. This synergy has led to a dramatic opening of the major economies
of the world. In 1970, for example, U.S. exports and imports accounted
for about 10.4 percent of U.S. GDP. By 1994, trade constituted 23.6 percent
of U.S. GDP, an increase of 127 percent. This opening to international
commerce has been mirrored around the world.
The Gains From Free Trade
American openness to international trade and investment enables the United
States to have a stronger domestic economy than would otherwise be possible.
Such gains from trade stem from the fact that not all economic activities
can be performed with equal proficiency in every country and not all firms
are equally competent in producing each line of goods and services. Trade
and foreign investment allow specialization to flourish by permitting,
or inducing, U.S. labor and capital to shift away from industries with
low returns and into those with high returns. Through trade, American
firms gain access to cheaper components and services from abroad. The
result is more cost-competitive domestic production of both goods and
services for the U.S. and international markets. By concentrating on the
production of certain goods and services and trading for others, Americans
can consume more of all products than would be possible without trade.
This is what economists call the doctrine of comparative advantage.
- U.S. Employment and Wages Rise
Export-related employment in the United States accounted for 23 percent
of new private-industry jobs between 1990 and 1994. Over the last decade,
jobs supported by exports rose four times faster than overall private-industry
job creation. As a result, 12 million Americans now owe their jobs to
exports, out of a civilian labor force of 67 million people.
At the level of the individual firm, jobs are created up to 18.5 percent
faster in companies that export than in companies that have never exported
or have stopped exporting. Moreover, exporting enterprises are less
likely to go out of business. And being employed by an exporting firm
is good for workers. A recent study found that both production and non-production
workers received 14.4 percent higher pay at exporting plants, plus benefits
that averaged 32.7 percent higher, than workers employed by firms that
did not export. As a result, the communities where export workers live
are better off. They enjoy growing tax bases and are less likely to
face periodic business downturns, falling real estate prices, and cutbacks
in community services.
- Demand for Skilled Labor Grows
Critics of free trade often argue that competition with workers in low-wage
countries is the reason wages in the United States have increased so
slowly for the last decade and a half, and that trade is to blame for
widening income inequality. Recent studies, however, suggest that imports
account for only about 15 percent of the widening pay differential between
skilled and unskilled workers. Most of the problem reflects the forces
of technological change and immigration.
This point is dramatically illustrated by Figure 1. Between 1967 and
1987, the ratio of less-educated workers to more-educated workers was
cut in half, in both industries that must compete with imported products
and export industries in the United States. In other words, over those
two decades, there was a sharp decrease in demand for less-educated
employees, relative to the demand for more educated workers. If this
trend had occurred only in import-sensitive industries, it might suggest
that foreign workers were taking jobs from low-skilled Americans. But
since it occurred in both export- and import-sensitive industries, it
is clearly a phenomenon driven by other economic forces that put a premium
on skills. It is also clear that the demand for skilled labor has been
the major force behind flat and falling wages for less-skilled American
workers. There is, of course, only one appropriate public policy response
to this trend: more intense education at all levels and lifetime training
and retraining.
| Figure 1 |
Number of Less-Educated Workers Required for Each More-Educated
Worker in Export and Import-Sensitive Industries |
 |
| Source: Baldwin and Cain (1995), Table 2, as cited
by J. David Richardson and Karin Rindal, Why Exports Matter More!
(Washington, D.C.: Institute for International Economics), 1996, p.
30. |
- Consumers and Businesses Benefit From Trade
Trade stimulates economic growth and reduces prices, enabling consumers
who earn more as workers to see their paychecks go further. While it
is impossible to precisely estimate the consumer benefits from trade,
it is roughly calculated that a 50 percent reduction in existing industrial
tariffs would increase the global economy by $270 billion per year.
A similar halving of agricultural protection would permit a $100 billion
cut in the world's food bill.
Trade increases the variety of goods and services available to consumers.
For example, forty years ago, during the long winter months, fresh strawberries
and raspberries were an unattainable luxury. Their availability was
limited to the "season," a few months or weeks in the summer
when local farmers brought in their harvests. Today, strawberries from
Mexico and raspberries from Chile are available throughout the winter
in all parts of the United States, thanks to a lively international
trade in agricultural products.
Business also benefits from trade because alternative sources of supply
enhance competitive pressures on domestic firms, forcing them to improve
their products and their methods of production to keep pace with the
competition. Alternative sources also reduce the likelihood of supply
bottlenecks in times of rapid economic growth or emergency. As a result,
companies can avoid the costly and destructive boom-and-bust cycles
of the past, when domestic production would be ratcheted up to meet
a sudden increase in domestic demand, only to be cut back, with layoffs
and idling of plant capacity, when domestic demand subsided. Now firms
can meet spikes in domestic demand by importing products from abroad
and can satisfy a sudden increase in foreign demand by exporting more.
In this manner in the late 1980s, the computer industry satisfied a
sudden demand for computer chips while new domestic capacity was coming
in line.
- Investment and Productivity Increase
The removal of impediments to trade and the resulting improvement in
the efficiency of resource allocation throughout the economy naturally
raises the rate of return on investment in tradable goods. The reduction
of trade barriers on industrial products due to the Uruguay Round of
international trade negotiations is expected to increase the real return
to capital in the United States by 0.3 percent. There is likely to be
a similar increase in the return on investment in Europe and Canada.
In countries where the service sector has been highly protected-such
as Japan-trade liberalization will similarly improve rates of return
for industries such as financial services and insurance. The real return
on capital in the Japanese service sector is expected to improve by
0.4 percent, thanks to the Uruguay Round. And the return on investment
in nations such as Korea and Taiwan is likely to rise 0.3 percent. Since
the tradable goods sector is generally capital intensive, a higher rate
of return on investment there will lead to faster overall capital accumulation
in the economy as a whole.
Exposure to new production and management technologies and to new products
due to international trade can foster productivity at both the industry
and plant levels. For example, exposure to the world market is what
transformed the U.S. auto industry from an aging dinosaur to an agile
competitor. Facing little competition from abroad, U.S. automakers inefficiently
produced lemons. Suddenly confronted with competition from well-built,
efficiently produced, and thus competitively priced Japanese-built cars,
the U.S. automakers were forced to clean up their act. The number of
man-hours needed to build a car was cut from 24.1 in 1989 to 20 in 1994.
- Costs of Economic Sanctions
In recent years, it has become increasingly popular for governments-especially
the government of the United States-to interfere with trade and foreign
investment as a means of punishing other countries for their political
views and actions. By curtailing or banning trade with another nation
or by sanctioning those who invest there, governments often hope to
improve human rights in the target nation, or force it to stop developing
dangerous weapons, or halt some other objectionable act. In U.S. political
life, this hope can be traced back to President Woodrow Wilson, who
believed that sanctions could bring a country "to its knees."
The most recent examples of all-out sanctions are the U.S. Helms-Burton
law [Cuban Liberty and Democratic Solidarity (LIBERTAD) Act of 1996]
that attempts to punish European, Asian, and Latin American firms for
doing business with Cuba, and the Iran-Libya Sanctions Act of 1996 that
attempts to punish firms that do business with those rogue states.
- Sanctions Usually Fail to Achieve Political Objectives
Despite the high-minded rhetoric that often accompanies the imposition
of sanctions, history suggests they usually do not work. A recent study
analyzing the effectiveness and costs of 100 cases of economic sanctions
between 1915 and 1990 found that only 34 percent of such actions achieved
their intended goals. Moreover, the success rate in the 1990s was lower
than that in the 1980s, and the success rate in the 1980s was lower
than that in the 1970s. In other words, while sanctions have been used
more frequently, their success in achieving foreign policy objectives
is less now than it was thirty years ago.
- Sanctions Cost U.S. Jobs and Reduce GDP Growth
This meager success rate comes at a high cost to the United States.
As intended, trade sanctions reduce trade, both exports and imports.
Financial sanctions may also reduce trade by denying investment, foreign
exchange, or credit to the target country or by raising its cost of
credit.
Moreover, U.S. exports lost today may mean lower exports after sanctions
are lifted, because U.S. firms will not be called on to supply replacement
parts or related technologies. And foreign buyers may design out U.S.
intermediate goods and technologies or decide against buying U.S.-made
final products in the future because they have decided American firms
are "unreliable suppliers."
In 1995 alone, U.S. economic sanctions against other nations may have
reduced U.S. exports to 26 target nations by up to $19 billion. Unless
there were offsetting increases in exports to other markets, these sanctions
deprived the U.S. economy of more than 200,000 relatively high-wage
export sector jobs and cost American families nearly $1 billion in higher
wages.
- A Better Approach to Foreign Policy
Domestic political pressure on a foreign policy issue can easily reach
a level where U.S. policymakers feel the need to "do something."
Given this political reality, U.S. policymakers who find themselves
considering the imposition of sanctions should adopt the following guidelines:
-Recognize that sanctions alone-even very severe sanctions-stand a low
probability of achieving most foreign policy objectives.
-Limit the frequency of sanctions applications by insisting on multilateral
measures. When multilateral cooperation cannot be achieved, sanctions
are probably not the right tool.
-Limit the collateral damage of sanctions, both to business interests
at home and to powerless civilians abroad, by concentrating their force
on punishing the elite. In other words, target sanctions on the leaders,
not the populace at large.
Conclusion
Outwardly oriented trade policies-policies that open the U.S. market to
foreign products and investment and that work to open foreign markets
to U.S. goods, services, and investment-maximize economic benefits for
American consumers, workers, businesses, and the economy at large. Efforts
to impede trade come at a high cost. They can seldom be justified in economic
or political terms.
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