This essay is adapted from The Next American Economy: Nation, State, and Markets in an Uncertain World, by Samuel Gregg (Encounter Books, 336 pages, $30.99).

The Next American Economy

In few areas is economic policy’s inseparability from politics more manifest than in global trade. In the period immediately following ratification of the U.S. Constitution, for example, trade debates within the Washington Administration became quickly entangled with arguments about what should be America’s stance vis-à-vis the spreading global conflict between France and Britain in the French Revolution’s wake. Similarly, when Congress and the executive branch today develop or modify trade policy, whether in a liberalizing or protectionist direction, it inevitably has political ramifications for both America’s allies and its opponents in the world.

One element of statesmanship involves accurately identifying and understanding the most relevant facts confronting a country as it pursues its national interests. Though economics forms an important part of that calculus, the legislator must take other criteria into account. What implications, for instance, does the government’s responsibility to uphold national security have for the type of products freely exchanged between American businesses and their foreign counterparts?

America has adopted protectionist practices at different periods to shape the nature of Americans’ economic interactions with businesses and nations throughout the world. Subsequently, harm was inflicted upon the American economy. But if the prime alternative—free trade—is to be advanced successfully in 21st-century America, it needs to occur in a manner fitted up for present geopolitical circumstances rather than those of the 1980s or 2010s. That does not mean downplaying the economic case for free trade. Nonetheless it does necessitate reexamining our assumptions about the environment in which that case is advanced. 

Trade in an Imperfect World

Following World War II, America committed itself to an agenda of trade liberalization between developed nations. This was not simply a question of American policymakers believing that free trade would deliver better economic results for America. It reflected the conviction that protectionism had exacerbated radical-nationalist trends in Europe in the 1920s and 1930s and thereby helped fuel the march to war. Rightly or wrongly, greater trade between nations came to be associated with greater peace. With this agenda being embraced by successive presidential administrations after 1945, the scale and depth of tariffs and quotas applied to imports by America fell. The picture is more mixed than this broad trend suggests, but the overall trajectory away from protectionism was clear.

By the mid-2010s, however, free trade was on the defense throughout much of America. While this owed something to perceptions about trade liberalization’s domestic effects, it also reflected broader disagreements about the nation-state’s place in a more economically integrated world and related questions concerning sovereignty. For some Americans, support for free trade had become associated with dreams of a borderless planet in which nation-states would be subordinated to supranational organizations like the EU as an ever-extending integration of national economies brings universal peace in its wake.

The irony is that there is no necessary association between free trade and ambitions of a peaceful, nation-free world. This was well understood by some of the leading figures of the movement most associated with the rise of free markets which exercised tremendous influence upon many of those at the heart of the American Founding. Scottish Enlightenment thinkers like Adam Smith and David Hume neither desired nor envisaged the disappearance of nations; they were also skeptical about strong correlations between free trade and a more peaceful world. A proper understanding of their position should inform how America thinks about trade openness in our time.

Both Hume and Smith were careful observers of international relations. Several of their commentaries focused on Britain’s relationship with its American colonies. But their starting point on these matters was always sovereign-states—not aspirations towards a pan-European federation of the type sketched out in 1713 by the Abbé de Saint-Pierre in his Projet pour rendre la paix perpétuelle en Europe and developed by Immanuel Kant in his 1795 Perpetual Peace: A Philosophical Essay. Hume and Smith were certainly part of the Enlightenment’s transnational world of letters. By 18th-century standards, they lived cosmopolitan lives. Yet they did not develop cosmopolitan affections, let alone sympathy for universal peace projects. Their approach to foreign relations was marked by deep realism about human nature.

Hume primarily explored foreign affairs through the prism of a balance of power between nations. This was the best basis, he believed, for a relatively peaceful world. I say “relatively” because Hume thought that human imperfectability meant there would always be tensions between countries that would occasionally spill over into outright conflict. Establishing a balance of power, he thought, was the most realistic way of limiting such tensions and would help restrain military conflict from escalating to the global proportions that he and other Scots witnessed during the Seven Years’ War.

Hume also doubted that the extension of free trade between nations, of which he was a strong advocate, would necessarily produce a more peaceful world. More countries, he reasoned, would become wealthier through free trade. Their governments could therefore maintain and increase their armies and navies and absorb the costs of war for longer periods. One finds traces of this insight in George Washington’s observation that “in modern wars the longest purse must chiefly determine the event.”

Adam Smith’s views on these matters were not far removed from those of Hume. In his Theory of Moral Sentiments, Smith didn’t argue that our sympathy for others stopped at borders. Smith did, however, believe that sympathy necessarily became feebler once it moved beyond the national level. Empathy for the human race and love of country were not, to Smith’s mind, incompatible, but they were not the same thing. “The love of our country,” Smith wrote, “seems not to be derived from the love of mankind. The former sentiment is altogether independent of the latter, and seems sometimes even to dispose us to act inconsistently with it.” Nations, according to Smith, are more part of our everyday cultural and historical reality than a generic humanity as a whole. Placing your country’s well-being before that of other nations was thus to be expected, even natural, and Smith regarded fighting and dying for one’s country as deeply honorable. Certainly Smith was no enthusiast for war. Part V of his Wealth of Nations details the substantial economic burdens which it imposes on nations. Nonetheless Smith agreed with Hume that such conflicts were part of the human condition.

Part of Smith’s critique of 18th-century mercantilism was that it exacerbated the potential for international conflict. Thanks to its beggar-thy-neighbor conception of wealth, mercantilism encouraged governments to think that national prosperity could only come at others’ expense. This mindset stimulated national rivalries, whether it concerned territory in Europe or colonies and trading rights in the Americas, Africa, and Asia. To the extent that free trade undermined many of these sources of conflict, Smith thought that it could encourage greater peace among nations. 

Nevertheless Smith didn’t imagine that free trade would render either war or nations obsolete. In the first place, Smith was skeptical that economic integration would gradually neutralize humanity’s propensity for conflict. Trade might ameliorate some of the international tensions associated with cultural and religious differences, but it wasn’t going to produce perpetual peace. This realism manifests itself in the exceptions which Smith made to his otherwise comprehensive advocacy of free trade. These included the use of retaliatory economic restrictions during trade wars, and protecting industries and technologies essential for a nation’s war-fighting capacities. These aren’t the conclusions of a crypto-pacifist who thinks that growing trade freedom will eventually dissolve the likelihood of clashes between countries.

Likewise, Smith’s advocacy in The Wealth of Nations of professional armies wasn’t just a question of applying the division of labor principle to national security issues. He also thought that professional armies were more effective than militias at conducting war and deterring aggression. The implication was that Smith didn’t believe that war or nations were likely to dissipate amidst a universal commercial pacifism. Indeed, Smith elaborated on Hume’s thesis that the increased wealth generated by free trade would allow countries to enhance their military capacities. Free trade, Smith believed, would make countries rich, but such wealth could be used to manufacture and buy weapons as well as build armies and navies. Echoing Hume, Smith specified that the growth in a nation’s “consumable goods” from an increasingly efficient economy would permit that country to support “fleets and armies in distant countries” and “carry on foreign wars,” whether through an enhanced capacity for military expenditures or a greater ability to sustain debt for longer time periods.

An example of what Smith envisaged might be the stupendous economic growth experienced by 19th-century Britain. This accelerated after the 1846 repeal of the Corn Laws—which had restricted food imports into Britain and kept food prices high—and successive British governments’ commitment to further trade liberalization. What’s often forgotten is that, absent the enormous wealth facilitated partly by free trade, it’s doubtful that Britain could have maintained the powerful navy which enabled it to enforce the Pax Britannica throughout much of the 19th-century world. Free trade had certainly helped enrich Britain, and some of that wealth gave Britain a capacity to project military force around the globe on a scale unmatched by any other 19th-century power.

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Mistakes and Expectations

This excursion into 18th- and 19th-century history illustrates how some of the most important free trade advocates refrained from overstating its positive effects. That circumspection went together with a conviction that countries were here to stay and that imperfect human beings would always be prone to some degree of conflict. 

Why is this relevant for our time? The answer is that many American policymakers and free marketers oversold the case for free trade from the 1980s onwards. By that, I do not mean that their economic arguments for free trade were wrong. But there was a tendency to overestimate free trade’s capacity to help shift many countries towards greater liberty, the rule of law, constitutionalism, and other Western ideals.

The biggest fish that many hoped would be caught in the free trade–free society net was China. Many American policymakers calculated that a steady integration of China into the global economy would be of mutual economic benefit for China and Western nations. They also held that trade might further a growth of commercial freedoms inside China. This in turn, they theorized, would soften the regime’s authoritarian character, gently create space for other domestic liberties, and help pacify China’s external impulses.

Certainly, this consideration was not necessarily at the forefront of American policymakers’ minds at the time. Trade negotiations are hard-headed affairs in which one-world sentimental humanitarianism is put firmly to the side as national representatives seek to secure the best bargain for their country. As Scott Lincicome points out, analysis of Clinton Administration speeches and policy documents illustrate that “creating a liberal democracy in China was not a primary reason for the U.S. government’s approval of China’s WTO accession.” Multiple domestic and foreign policy objectives, ranging from better market access for U.S. companies to promoting stability in the Taiwan Strait, were being pursued.

That said, one need only read various presidential statements at the time to see that a more freedom-friendly China was part of the hopes, if not a mild expectation. This can be observed in President Bill Clinton’s speech of March 9, 2000, at John Hopkins University explaining why, in his words, “Supporting China’s entry into the WTO . . . is about more than our economic interests.” China certainly represented an enormous opportunity for American businesses and lowered the costs of many products for American consumers. Yet Clinton also maintained that it would help in shifting China towards becoming a freer country. “Membership in the WTO, of course, will not create a free society in China overnight or guarantee that China will play by global rules,” Clinton commented. “But over time, I believe it will move China faster and further in the right direction, and certainly will do that more than rejection would.”

That same year, the Republican contender in the 2000 presidential election made similar comments. Alongside claims that China’s ascension to the WTO would serve America’s national and economic interests, George W. Bush argued that China’s further integration into global markets could help move the country toward greater domestic liberty: 

First, trade with China will promote freedom. Freedom is not easily contained. Once a measure of economic freedom is permitted, a measure of political freedom will follow. China today is not a free society. At home, toward its own people, it can be ruthless. Abroad, toward its neighbors, it can be reckless. . . . I view free trade as an important ally in what Ronald Reagan called ‘a forward strategy for freedom.’ The case for trade is not just monetary, but moral, not just a matter of commerce, but a matter of conviction. Economic freedom creates habits of liberty. And habits of liberty create expectations of democracy. There are no guarantees, but there are good examples, from Chile to Taiwan. Trade freely with China, and time is on our side. . . . Simply put: China is most free where it is most in contact with the world economy. 

Clinton and Bush were careful to insert caveats throughout their respective comments. They were not saying that enhanced participation in global markets was guaranteed to push China towards a broader embrace of the habits and institutions of freedom. Nonetheless, this was a period in which many policymakers were influenced by the 1992 thesis outlined by Francis Fukuyama in The End of History and the Last Man: that the collapse of Communist systems in 1989 foreshadowed a coming “end-point” in “mankind’s ideological evolution,” this being the eventual “universalization of Western liberal democracy as the final form of human government.” There might be temporary lapses on this Hegelian high road to liberal order and the journey might be long, but the destination was settled. More-or-less liberal democracies and more-or-less market economies were the future.

Things did not quite turn out that way in China. As Stephen Ezell explains in detail, China did not abide by some basic commitments expected by any WTO member “on issues such as industrial subsidization, protection of foreign intellectual property, forcing joint ventures and technology transfer, and providing market access to services industries.” There is good reason to doubt that China ever intended to keep its promises. Instead of adopting the broad market liberalization agenda expected of WTO entrants, Chinese economic policies were more akin to those of an 18th-century mercantilist state. More generally, political liberalization never materialized.

American recognition of these facts was signaled by the National Security Strategy issued by the Trump Administration in 2017. Many national security and foreign policies of previous administrations, it stated, had been “based on the assumption that engagement with rivals and their inclusion in international institutions and global commerce would turn them into benign actors and trustworthy partners.” But, the document then added, “For the most part, this premise turned out to be false.” This conclusion was not one limited to conservative Americans. One year later, two former senior Obama Administration officials stated in a Foreign Affairs article that Democratic and Republican administrations “had been guilty of fundamental policy missteps on China.” That included mistaken assumptions of trade’s long-term effects on China.

While trade with China has delivered considerable economic benefits to Americans, political and economic trends in China did not shift in the anticipated direction. By the late-2010s, the Chinese regime had become even more authoritarian, increasingly less market-orientated in its domestic economic policies, even less transparent about the true state of Chinese businesses and the economy, and more aggressive in its approach to other nations.

The question thus becomes: where does America go from here vis-à-vis free trade in general and China in particular? Political rhetoric is inhibiting clear reflection upon the optimal way forward for America with respect to China. On parts of the Right, we hear calls for an “immediate” decoupling of the Chinese and U.S. economies. Few are outlining precisely how that might occur or acknowledging the subsequent costs that would be incurred by American consumers and businesses. From sections of the Left, we hear a parroting of Xi’s lines about China’s deep commitment to international law.

To my mind, there are two preconditions to any successful path forward. First, there must be recognition that America’s approach to trade cannot return to a 2000-2016 outlook or set of expectations. Second, Americans need to reexamine the relationship between trade liberalization and national security in a manner cognizant of: 1) basic economic truths about how trade benefits American consumers, businesses, and workers; and 2) the fact that trade policy cannot be separated out from foreign policy considerations. That, I concede, is an extraordinarily difficult balancing act, but it should not be beyond us.  

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How America Wins Through Trade

Any resetting of trade policy requires recognition of the very real benefits that free trade can and does confer upon the United States. America’s long-term economic prosperity and international competitiveness is, I submit, significantly dependent upon openness to international trade. One key to grasping why this is the case is the concept of comparative advantage. This requires elaboration. 

Given embryonic expression in Smith’s The Wealth of Nations before being further developed by the British classical economist David Ricardo in his Principles of Political Economy and Taxation (1817), comparative advantage is the capacity of a country to produce a particular good or service at a lower opportunity cost to itself than another nation. This means that a nation gains by: 1) exporting what it has a comparative advantage in producing; and 2) importing those things which other countries have a comparative advantage in producing. Trade conducted on this basis makes each country better off because, Pierre Lemieux notes, “each country produces what it can produce at lower cost and imports what others produce at lower cost.” This holds even if a country possesses an absolute advantage in every single sector of its economy over another nation. Israel might be able to produce more manufacturing goods and technology than Australia. It is still, however, the case that Israel can obtain more manufactured goods from Australia by specializing in technology and trading some of that output for imported manufactured goods.

America therefore benefits by specializing in the production of goods and services in which it has a comparative advantage. America’s comparative advantage in high tech, for instance, enables it to produce and sell high tech faster—and at more competitive prices than anyone else—to Americans and millions of others around the world. That is good for American companies and workers in such sectors. People and industries in other countries do the same in other areas like clothing. They benefit from our technology; we benefit from their clothing. 

Capitalizing on comparative advantage can also involve companies in different nations producing particular parts of a given product, other businesses in other countries assembling the parts, and the marketing and distribution of that product being undertaken by yet other companies in a third set of nations. Many parts for planes made by American companies are built and assembled in a series of countries and then integrated together in the United States. The overall effect is to reduce costs and increase efficiencies across the board for American businesses, thereby reducing prices for American consumers.

This does not mean that America’s comparative advantages vis-à-vis other nations are somehow fixed. Economists have always recognized that comparative advantage isn’t static. It can be affected by institutional factors like corrosion of the rule of law in a given country, or economic developments fueled by entrepreneurial discoveries or improvements in a nation’s competitiveness. It doesn’t, however, follow that government officials can somehow predetermine America’s comparative advantage in international markets. The very fact that a country’s comparative advantages are developing and changing vis-à-vis that of other nations makes this extremely difficult. 

Trade openness helps American businesses to maximize the benefits of pursuing comparative advantage insofar as it provides them with greater access to foreign markets in which to trade and sell their products: the bigger the potential market, the greater the capacity for sales and profits. This is a major reason why so many American businesses were anxious for China—a market of 1.4 billion people—to enter the WTO in 2001. At the same time, trade openness brings more and more competitive pressures to bear upon the American economy, and thereby amplifies the benefits which go along with enhanced competition for American consumers and businesses. As for American workers, trade openness has a positive effect on labor productivity. That matters because in a developed nation like America, a higher degree of average labor productivity generally translates into higher average wages.

Critics maintain that, in conditions of free trade, American workers cannot compete with Chinese workers without enduring substantive wage reductions. But this argument misses two points. First, under free trade, more and more workers will gravitate over time to different and more productive and often less physically intensive economic sectors along with the higher wages associated with that. Second, the value of the real wages of American workers will increase insofar as they are able to buy more things which have become less and less expensive, thanks to free trade.

Lastly, there is a crucial and broad benefit of free trade to the United States: it increases GDP growth; that is, the growth of total income over time. It has been estimated, for instance, that between 1950 and 1998 “countries which liberalized their trade regimes experienced annual average growth rates that were about 1.5 percentage points higher than before liberalization.” Or, as an IMF/WTO/World Bank study of the relationship between trade and growth stated, “In advanced economies . . . the rising living standards that came with greater trade openness lent widespread support to the view of trade as a key engine of economic growth.” The extent to which this occurs is influenced by factors like the quality of institutions in a given country. Nonetheless tariff reductions do appear to contribute to higher growth, which translates into expanding wealth, jobs, and consumption.

This is good news for Americans and magnified by the fact that trade across borders significantly contributes to increases in per capita income: i.e., average income earned per person in a given area in a specified year. The IMF/WTO/World Bank report cited above observed how “Cross-country evidence suggests that the effect of trade on income has remained consistently positive over time, although it has somewhat diminished since the global financial crisis.” It then estimated that “a one percentage-point increase in trade openness raises real per capita income by 2 to 6 percent.” The same trade openness also results in lower consumer prices, whether through a lowering of tariffs imposed on imported goods and related pro-competition effects, or, more indirectly, through the associated productivity gains by domestic and foreign firms. Significantly, the pay-off is greater for less wealthy American consumers. Not only do they benefit from lower prices; those on lower incomes tend to spend proportionately more on internationally traded goods like manufactured and agricultural goods, while wealthier Americans spend more on goods like health and education that are less traded across borders. 

The tangible economic benefits for America which flow from trade openness have positive spillover effects in other areas. If America did not enjoy steady economic growth over time, for example, its capacity to fund (as Hume and Smith understood) a strong military would degrade alongside its ability to project power abroad. It’s also the case that the more the American economy grows, the greater its ability to attract foreign capital and reduce the size of its public debt as a proportion of GDP. Certainly, trade openness isn’t responsible for all or even most of America’s growth, but it does make a substantive contribution. We are sometimes inclined to take economic growth for granted, but it is not the norm in human history. Even a one percent difference in economic growth can have substantive implications for the American economy, which itself is an indispensable (though insufficient) basis for America’s status as a world power.

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The Negative Effects of Free Trade

But many Americans question whether such benefits have, in the greater scheme of things, been worth it. One effect of trade liberalization is that it introduces dynamism into society. Not everyone copes as well as others. Once-protected industries can find themselves in deep trouble as tariffs are lowered. Many American businesses thrive as they embrace the opportunities created by opening export markets across the world, and all Americans benefit from lower prices. But some companies close because they can’t compete or adjust. In such cases, some people lose their jobs. Not all of them find new employment easily, often because of their age or lower demand for their skillset.

This, however, needs to be put into perspective. Despite the disruption caused by increased competition and imports from China in the 2000s and the negative impact this had on some areas with significant numbers of less-educated workers, Scott Lincicome illustrates that the majority of U.S. regions ultimately found themselves better off as far as jobs and economic output were concerned. A similarly positive picture can be found in Alan Berube and Cecile Murray’s 2018 analysis of how older industrial towns in regions like America’s Northeast and Midwest have fared since the 1970s. Of the 185 U.S. counties they identified as having a disproportionate share of manufacturing jobs in 1970, Berube and Murray illustrated that approximately 115 had managed to switch successfully away from manufacturing by 2016. Of the other 70, 40 had exhibited “strong” or “emerging” economic performance between 2000 and 2016.

The fact that there are far fewer permanent rust-belt towns than supposed is a helpful corrective to popular narratives, but it is not to trivialize the adjustment costs. There was considerable upheaval in those four decades between the 1970s and 2010s. Moreover, while the number of such people and places negatively affected in a lasting and deep way is fewer than often supposed, it cannot be treated as collateral damage. Yet it would also be irresponsible to sacrifice most of the benefits of open trade to protect particular jobs in one industry at the expense of more than 330 million American consumers by deploying measures like industrial policy, which have poor track records in realizing their stated goals and perpetuate deep economic and political dysfunctionalities.

One way in which America and other countries have sought to smooth the process of change is through baking trade adjustment programs into trade treaties. These endeavors, however, have had mixed and sometimes counterproductive results. As one team of economists reported:

Trade Adjustment Programs . . . aim to provide additional and temporary support to workers displaced by trade, including for retraining. These programs can play an important political role, enabling trade agreements to be ratified when they would not otherwise, but the experience with them has been largely disappointing. It is not always evident who is displaced by trade or by domestic competition or automation. The US program, for example, has been found to have only limited uptake . . .

These programs may thus help secure trade deals, but they are hard to target. How do you determine which individuals have been let go because of trade liberalization, and distinguish them from those who lost jobs because of the introduction of new technology? Indeed, there is much evidence to suggest the dislocation generated by trade represents only a small part of job churning. Adjustment programs can also have unintended negative consequences. In some cases, they slow down the flow of the benefits of trade openness. There are also many instances of temporary adjustment measures morphing into yet more permanent government programs.

A better way of addressing these problems is to increase ease of mobility for labor and capital among firms in the same economic sector, across such sectors, and between regions and localities. Americans are more inclined to move for work than, say, Western Europeans. At different points of American history, this has taken on mass proportions, such as when millions of African Americans moved from the segregationist South to Northern states, or when Americans migrated across the continent from Eastern states to the West throughout the 19th century. In both instances, the movement primarily consisted of poorer people who stood to gain by moving to areas where there was more widespread economic opportunity.

Moving, however, is not made easy when it incurs high transaction costs. Harvard economists Edward Glaeser and David Cutler point out that between 2007 and 2020, geographic mobility in America decreased by one-third, with fewer than 4 percent of Americans changing counties annually. The primary reason for this, they maintain, is that insiders in some of the country’s most prosperous regions and cities actively use regulations and laws to make it difficult for outsiders from other parts of America to enter these communities. The more, for instance, the housing market is regulated via zoning rules or significant restrictions on further development, the higher the price of housing and the lower the likelihood of people with fewer means being able to find somewhere to live.

Increasing mobility thus means decreasing transaction costs. This requires making it simpler and less expensive for people to access capital, accept new jobs, or acquire new skills through education. There are also very specific measures which can be taken, whether it is eliminating unnecessary licensing requirements that make it harder for people from one state to pursue jobs in other regions, or, as Glaeser and Cutler suggest, states legislating to allow local government only to impose regulations and rules that have been subject to rigorous cost-benefit analysis.

None of this is to pretend that mobility is a cost-free exercise, psychologically or economically. Even necessary or good change can be hard. That is part of the human condition. But if we want the U.S. economy to grow and flourish, mobility is essential, and we increase mobility by removing barriers to movement. Here we should recall that the entire history of economic development is one of mobility and transition: from rural areas to cities, from agriculture to factories, and from factories to service-provision. If the American economy is to continue growing and competing with the rest of the world, people and material resources must continuously shift to higher value-added sectors, and, within specific sectors, to the more efficient firms. There are trade-offs associated with this, but they are generally worth it—not least because of the many drawbacks associated with the protectionist alternative. It is frankly imprudent to encourage Americans to stay in industries losing comparative advantage or to remain in occupations that competitive pressures from abroad and, even more so, technological change are making redundant.

Reprinted with permission from The Next American Economy: Nation, State, and Markets in an Uncertain World by Samuel Gregg, published by Encounter Books. © 2022 by Encounter Books. All rights reserved.

About Samuel Gregg

Samuel Gregg is Distinguished Fellow in Political Economy and Senior Research Faculty at the American Institute for Economic Research, and an Affiliate Scholar at the Acton Institute. The author of sixteen books, he has written and spoken extensively on questions of political economy, economic history, monetary theory and policy, and natural law theory.

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