PROTECTIONISM—THE SCOURGE OF MARKETS IN THE NEW WORLD ORDER

Presented at the Chicago Mercantile Exchange and Chicago Board of Trade
Fourth Annual International Finance Symposium,
Tokyo, Japan,
April 8, 1992.

Protectionism—no different than intervention in exchange rates and other forms of government interference with free market processes—represents a dangerous and slippery slope. Such endeavors often come unannounced in small insidious increments, sometimes in the form of sophistry and fallacious reasoning. If we are not vigilant in our opposition to these man-made encroachments to market-driven economic order, they will take us down this slope and snatch defeat from the jaws of victory.

It is noteworthy that U.S. Senator Phil Gramm thought so highly of this address that he entered it into the Congressional Record on May 5, 1992 (Page S-5933).

It represents a paradox of unimaginable proportion. At the very moment in history when the triumph of free markets is nearly global—at the very moment in history when market-driven economic order is embraced in such unlikely places as Moscow, Sofia, and Prague—at the very moment in history when the Communist world has discarded the manifesto of Karl Marx in favor of the principles of Adam Smith—at this same moment in human history, some of the staunchest champions of a liberal world economy, free trade, and uninhibited competition have suddenly developed a severe case of second thoughts.

Even as the bust of Lenin unceremoniously disappears from every pedestal in the Communist world, even as endless teams of economists from Eastern Europe travel to America to study market-driven economic order, even as central planning becomes a ridiculed concept throughout the former Soviet Union, some within the bastions of free market economics in the United States and Europe are talking of industrial policies, protectionism, and tariffs. The philosophical incongruity of this phenomenon is difficult to comprehend. It would be comical were it not so tragic.

What happened? Have we lost our faith? Our nerve? Or have we simply lost our memory and are condemned, as Santayana suggested, to repeat past mistakes?

Surely our memory cannot be so short that we have forgotten Senator Reed Smoot of Utah and Congressman Willis Hawley of Oregon who together devised the so-called Smoot-Hawley Tariff Act of 1930, the Act that resulted in a trade war and according to most economists helped plunge the world into the great depression of that era.

Those who suddenly again question our liberal global economic philosophy suggest that the U.S. has been duped in a world that does not operate according to classic economic principles. That we are naive fools in a cut-throat competitive world that has few rules and that is ruthlessly unfair to nice guys. No question some of this has the ring of truth. There exist areas of unfair global competition. There exists a network of protected industries that take advantage of American good will. But there is nothing new about that, nor is the U.S. itself free from unfair trade practices. While we must be unrelenting in our efforts to erase such sins, they are meaningless in the sum total of our successful global course over the last half century. What has brought the protectionist voices to the fore has been the special economic circumstances of current vintage—principally the long and difficult American recession. It has created an emotional environment, one based on fear and distrust; it has created an atmosphere fertile for sophistry and demagogues.

Specifically, anti-liberal economic theorists advance two major myths to support their views: that protectionism is justified by U.S. trade imbalances and that protectionism saves jobs. Both myths are false. They have again come into fashion, as Daniel Oliver the former Chairman of the U.S. Federal Trade Commission observed a few years ago, by virtue of special interests in America; i.e., some industries adversely affected by foreign competition have invented a national problem in order to advance their own self interests.

That protectionism will create jobs is a claim that Herbert Stein, the American Enterprise Institute scholar, has characterized as "best selling fiction." While it is true that a protectionist policy will create jobs in the particular industry being protected, it is equally true that it will have a devastating effects and cost jobs in the economy as a whole. By savings jobs through trade protectionism in (say) the machine tool industry or the computer chip industry, it will be at the expense of jobs in manufacturing or jobs in electronics. Because when a foreign country cannot export its products to the protected country, it has less money to spend on imports from the protected country. The protected country will thus lose some other export market that will force some other corner of its industry to reduce its labor force. As Milton Friedman told us in Free to Choose, "The gains to some producers from tariffs and other restrictions are more than offset by the loss to other producers and especially to consumers in general."(1)

Similarly, the myth about the U.S. trade deficit negatively affecting the U.S. economy is simplistic and equally untrue. As should be obvious but is often misunderstood, a trade deficit (the so-called current account deficit) is not something that is good or bad per se. It is merely the counterpart to a capital account surplus. Exports are not by themselves good nor are imports bad. A favorable balance of trade basically means exporting more than we import; i.e., shipping goods abroad of greater total value than the goods we get from abroad. In other words, sending more than we receive. If the reverse occurs—when we receive more than we send—strange as it may seem, it creates an unfavorable balance of trade.

During the 1970s, for instance, the U.S. had a trade surplus and a deficit in the capital account, partly because of large U.S. investment overseas. Was that good? In the 1980s, the U.S. began running a surplus in its capital account; the favorable climate for investment in the U.S. was causing an influx of foreign capital. This was used to partially finance a major retooling of American production capacity. Is this bad? If the rest of the world is to invest—on net—in the U.S., the U.S. will necessarily run a trade deficit. As most economists and scholars will tell you this is neither good nor bad. Nor does the trade deficit take away jobs as protectionist rhetoric in guise of national concern will attempt to tell us. For instance, during the 1980s, even as our trade deficit continued to mount to record levels, the United States continued to produce new jobs at a very high rate. As everyone in Japan is aware, the brunt of the current protectionism attack has been directed at this country. Japan's economic miracle of the past several decades has made the rest of the world envious. Thus, the tapestry of free trade is shamelessly being rewoven into something called fair trade, a buzz word for protectionism; an America-first syndrome, the equivalent to a fortress-Europe mentality, is disgracefully trampling on the sacred precepts of global competition; the time-honored principles of a market-driven economy are outrageously attacked in favor of short-term solutions, political expediency, and emotional rhetoric. Japan has become the whipping boy for the world's economic problems.

Does anyone care to listen to the truth. For instance, although the U.S. 43 billion trade deficit with Japan is blamed for the American recession, in truth its impact on the American economy is relatively small—equal to 2 day's worth of U.S. output. Excluding autos, the U.S. deficit with Japan is not much more than it is with China. In fact, the U.S. total trade deficit—66.2 billion in 1991—fell below the 100 billion mark for the first time in 8 years. At the same time, U.S. exports surged to a record 422 billion and the U.S. captured a greater share of worldwide manufactured exports than Japan. Indeed, the U.S. exports more to Japan than it does to Germany, France and Italy combined. Conversely, Japan imports more per capita from America and at a higher percentage of its gross national product than the U.S. imports from Japan.(2)

In truth, the U.S. export picture has been the one bright spot in the American economy; if a recession or an economic slowdown is occasioned by U.S. trading partners or if protectionism has its way, the American economy will be hit even harder.

However, the rationale for protectionism and tariffs is unencumbered by the truth; it is built upon false assumptions, inaccurate impressions, and demagogic sentiments. For instance, Japan is said to be an unfair trader. This is an erroneous accusation. While Japan is not without guilt, it is on the whole no different than other industrial countries. In fact, on average, Japan trade barriers are lower than other industrial nations. Its average tariff for industrial products is 2.6%—compared with 3% for America—and its non-tariff barriers, such as quotas and licenses, are similar to those in America.(3)

These facts are not well understood or publicized in the United States, nor are they sufficient to offset the frustrations resulting from our long and deep recession, unemployment in excess of 7%, and an ongoing U.S. election process. This combination of circumstances has created a climate ideal for those motivated by self-interests. Indeed, sophistry and demagogic polemics are very effective tools in times of economic stress, especially in a political year. Take the American auto industry as an example. Some of their executives would have us believe that the problems occasioned by their industry are not caused by competitive value comparisons on the part of U.S. consumers, but are the result of a Japanese government plot, one that has caused the current U.S. trade deficit. Consequently, the problem, they argue, is of national concern.

Of course there is nothing new about the use of such sophistry by merchants and manufacturers to advance their own special purposes in the guise of a national necessity. Sophistry in commerce has been applied throughout the ages. It was best described by Adam Smith in 1776, in The Wealth of Nations:

In every country, it always is and must be the interest of the great body of the people to buy whatever they want of those who sell it cheapest. The proposition is so very manifest, that it seems ridiculous to take any pains to prove it; nor could it ever have been called in question had not the interested sophistry of merchants and manufacturers confounded the common sense of mankind. Their interest is, in this respect, directly opposite to that of the great body of the people.(4)

As Milton Friedman will tell you, "These words are as true today as they were then." It is always in the best interests of the vast majority of the people to buy from the cheapest source and sell to the dearest.(5) Yet, sophistry, motivated by special interests, will attempt to tell you that this is not the case and that there are national priorities at stake. The national priorities just happen to coincide with the special interests of the merchants and manufacturers Adam Smith wrote about.

Nor is protectionism, sophistry and demagogic polemics exclusive to the United States or Europe. Such endeavors know no geographic boundaries. Here in Japan, the same or similar political expediencies, sentiments and actions are exercised covering a wide range of commercial enterprises including protecting domestic industries at the expense of international trade, exclusive arrangements among Japanese companies, keiretsu transactions, and even the blaming of the futures index market in Osaka for falling stock prices in Tokyo. Such actions are the cause of the unwarranted image Japan has earned. For instance, the proposed Japanese restrictions on derivative trading activities can be assessed by financial markets as an attempt to punish the profitability of foreign brokers— primarily U.S. institutions. Is this other than protectionism? Is it not sophistry to suggest that such measures will correct the perceived problems in Japanese markets? Similarly, when a Japanese official recently stated that American workers are "lazy and illiterate," his words were not only a disservice to the cause of free trade, they were blatantly false.

While Japanese do have more working hours than Americans—225 hours per year more than U.S. workers—American workers rank second in the number of work hours of any nation in the industrialized world. Americans work about 320 hours more per year than workers in Germany or France. Indeed, working hours in the U.S. have increased substantially over the past twenty years. From the end of the 1960s to the present, Americans' work hours have increased by about 160 hours (or nearly one month per year). This is true for women as well as men.(6)

Similarly, it is a fallacy that the productivity of American workers has fallen. The level of productivity of the U.S. worker has more than doubled since 1948. And as for leisure time, American and Japanese workers on average receive the same 10 days vacation time—well behind the thirty days of vacation for Swedish or Austrian workers, or the twenty-five days in France, or the twenty-two days in the U.K., Switzerland and Spain, or the eighteen days in Germany.(7)

And while the negative comments about American workers were probably made for domestic rather than foreign consumption—possibly to forestall the growing pressure from Japanese laborers to reduce working hours (just as many of our negative comments about Japan are made for domestic U.S. consumption)—they nevertheless can cause serious difficulties for the relations of our two nations. It therefore behooves public officials on both sides of the Pacific to bear this in mind. That particularly during times of recessions—as the U.S. has endured, as most of Europe is experiencing, and as may yet be felt here in Japan—it is imperative that the voices of our public officials be less shrill and that they not unwittingly lend ammunition to those who have a special protectionist agenda.

For we know that protectionism has popular appeal. We know that in times of economic strain protectionism can gain a following. But we also know that protectionism is the scourge of markets everywhere. We know its consequences are devastating and ubiquitous. Dare we allow the near global triumph achieved by free markets in recent years be diminished? Dare we endanger the new world order we have fought so long and valiantly to achieve? Dare we allow the protectionists of the 1990s to lead us down the Smoot-Hawley path of the 1930s? Sophistry and demagogic polemics can snatch for us defeat from the jaws of victory. We, of free markets, must not allow this to transpire.

Thank you.

____________________

     (1) Milton and Rose Friedman, Free to Choose (1980).

     (2) U.S. News & World Report, March 12, 1992.

     (3) The Economist, January 11, 1992; World Bank.

     (4) Adam Smith, The Wealth of Nations (1776).

     (5) Free to Choose.

     (6) Newsweek, February 17, 1992.

     (7) Ibid.

Reprinted by permission. Excerpted from Melamed on the Markets, by Leo Melamed. John Wiley & Sons, 1993

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