The Illusion of Free Trade

By George Friedman


The United States’ decision to impose tariffs on steel and aluminum imported from certain countries has added to the fears of a trade war. Some believe that these tariffs are a dangerous move by the U.S. because they will invite retaliation and thus could lead to a massive breakdown of trade. The problem with this way of thinking, however, is that it focuses primarily on formal barriers to trade and ignores informal and indirect barriers. Even if there is a free trade agreement between two countries, it does not necessarily mean that businesses in both countries will be able to trade with each other without impediments, as is often assumed.

Governments have a range of tools available, formal and informal, designed to mitigate the effects of free trade. In other words, a free trade agreement will eventually evolve into something very different. For example, regulations can be put in place that impose massive additional costs on an exporting country, forcing increases in prices. This wouldn’t involve the imposition of tariffs, but it would make it more difficult for exporters to compete with domestic manufacturers. Antitrust laws can be implemented that fine companies and force them to cut back their market share. The cost of domestic production can be reduced by relaxing labor laws. Countries may also enter into agreements knowing full well that their consumers have little interest in certain imports, such as Japanese consumers spurning American cars. And exporters may be forced to sell products in a country through certain wholesalers that dominate the domestic market, and having to do that may slash their revenue.

Free trade, in its purest form, is said to be financially beneficial to all countries. That may be true, but this assumption ignores three vital variables. The first is timing. When will the benefits will show themselves? It could take years or even decades. The second is short-term vs. long-term impact. Some industries may become uncompetitive and even collapse before others flourish. The third is is how patterns of economic activity change based on foreign competition. Some businesses will win, others will lose.
Free trade is not only an economic process but also a political one. The destruction of an industry can destroy the livelihoods of millions of people, even if the country’s gross domestic product surges. In economics, the assumption is that individuals will pursue their self-interest. Oddly, economists tend to assume that they will – or at least ought to – pursue those interests only through economic activity. But people can also pursue their self-interest politically. A government that negotiates a free trade agreement that damages this generation with the promise of better things later is likely to face serious political repercussions. The next government will take a different approach.

Economics is a subset of politics, and the political system moves to protect the interests of citizens to maintain social stability and, in democracies, keep governments in place. The focus on tariffs misses the reality of international trade, which has both an economic dimension, focused on increasing the wealth of nations, and a political dimension, focused on assuring that the wealth doesn’t flow into the hands of a few while the rest are left devastated.

The United States is not yet in this extreme condition, but it has entered into a series of trade agreements that, while beneficial on the surface, have had some negative consequences. The most important consequence has been the transfer of factories out of the U.S. to low-wage countries. By the law of comparative advantage, this should in the long run benefit the United States. But it will do so at a massive cost to one sector. GDP might rise, but that in no way indicates that wealth would be distributed in a way that the political system can endure.

Every government has to consider three factors when entering into a trade agreement. The first is the benefit to an industry that will have access to a new market. The second is the damage the agreement will do to those who will lose their jobs. The third, and trickiest, is how the foreign government with whom the trade deal is agreed will use non-tariff tools to shift the agreement to their advantage and, by definition, against their trading partner.

People shouldn’t worry about a new trade war emerging because a constant and intense guerrilla war is already underway in every trade regime to undermine the agreement and reshape it through subtle intrusions. This is why multilateral trade agreements have grown so troubling. A trade agreement that creates a single regime encompassing drastically different economies is inherently implausible. The non-tariff trade barriers in each country, not to mention the challenges of monitoring and enforcing the agreement, create mindboggling hurdles. The World Trade Organization can be used to settle some disagreements, but its decisions can be difficult to enforce.

Free trade is rarely free, and when it is free, it imposes costs in unexpected places. The decision of the U.S. to force a renegotiation of trade relations is a result of the fact that certain sectors of the U.S. economy have been hurt by prior trade regimes, and the U.S. is now using the political process to pursue its self-interest. This is not new, nor is the surprise of those who have benefitted from the old regime or who are ideologically committed to the illusion of free trade. It is part of an ongoing shift in economic relations driven by political realities.

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