Free Trade Agreements Revisited
Reading about the poor condition of free trade agreements, including that they don’t mention “free trade” anymore, one may be forgiven to believe that trade—exchanging x units of good X for y units of good Y or currency Z—is the most complicated thing in the world. (This post was inspired to me by reading “In New World of Trade Diplomacy, Free Trade and Tariffs Take a Back Seat,” Wall Street Journal, May 7, 2023.)
To cut the Gordian knot, consider two general theories of free international trade. One starts with the admission that your own government may prevent you from importing or exporting as you wish, and so can foreign governments against their own subjects. In this perspective, a “free trade agreement” is a treatise between two or more governments to allow their subjects to trade together under certain well-defined conditions. This has become more complicated as political clashes between the ambitions of national governments (or customs union) have deepened. “Free trade agreements” between governments have become rarer, more restrictive, and only remotely concerned with what merchants call trade.
The other general theory is that a free trade agreement is simply an agreement between two parties, an importer and an exporter, to exchange something (good or service or money) over an international border. Whether you are an exporter or an importer, what matters is not so much, or not really, whether foreign tyrants prevent their subjects from trading with you, but whether your own national government will interfere in any contract you are willing to conclude with another voluntary and capable party. This second theory is the essence of what classical economists, in the wake of Adam Smith, David Hume, or David Ricardo, considered free trade. It is not that complicated—if you live in a free country.
I neglect a third theory, not very credible, that implicitly claims that nations or states are big biological organisms or superindividuals, and are the subjects of the verb “to trade.”
The objection that free trade requires everybody in the world to be as free as you are, or as you should be, is not realistic. The world is full of obstacles, man-made or not, surmountable or not, which get baked in what we call “comparative advantage.” The prosperity of the country you live in depends mainly on your freedom and that of your fellow citizens (“fellow residents” is a more proper expression) to adapt to the world without further constraints from your own government.
To paraphrase Joan Robinson, it is not because your customers have rocky coasts that your own government is justified to throw rocks in your harbour. To use another analogy, protectionism is like if, confronted wit a foreign tyrant prohibiting his subjects to travel to visit you, your own Leviathan retaliated by forbidding you to travel to meet them.
The main, if not the only, justification for a “free trade agreement” between your government and the government of somebody else is to tie the hands of your own Leviathan and limit its “state capacity.” In this, you stand in solidarity with your fellow human of the other country who wishes to defrang his own Leviathan. When nobody, or at least nobody in power, believes in that goal, no wonder that such protective free trade agreements have become unpopular. (See also my 2017 EconLog post “Taking Comparative Advantage Seriously.”)
Knut P. Heen
May 9 2023 at 8:47am
Free trade is a public good. We favor free trade in everything except my trade. Everyone thinks the same. Hence, we have free trade in nothing. We need to commit to free trade in a constitution which is not living to avoid the prisoner’s dilemma trap.
May 9 2023 at 1:04pm
I don’t think it’s actually true that “we have free trade in nothing.” And I know that it’s true that we have much freer trade, in the United States and in the world, than we had after World War II. Tariffs fell substantially and kept falling from about 1945 to about 2000.
May 9 2023 at 11:40pm
1. I suggest that in recent decades pretty much every so-called free trade agreement has in fact been a customs union. That is certainly true of USMCA (formerly NAFTA).
2. Whereas under the GATT (1948-1994) the emphasis was on multilateral tariff reduction, under the WTO (1995-) the goals have expanded, including the strict enforcement of comprehensive intellectual property rights with regard to both their scope and duration. This reflects the changing hierarchy of interests of U.S. economic actors. The interests of consumers of foreigners’ intellectual creativity (prior to 1891 the U.S. offered no protection for literary works by British authors) yielded to the interests of U.S. creators of intellectual property in the twentieth and twenty-first centuries.
May 10 2023 at 11:36am
Mark: About your first point, doesn’t a customs union require common external tariffs (external to the union)? Or do you mean that rules of origins are the equivalent?
May 11 2023 at 8:09pm
A customs union requires a common external tariff. That was a fundamental difference between the European Economic Community (EEC) and the European Free Trade Association (EFTA), or to borrow the title of Emile Benoit’s book, Europe at Sixes and Sevens (1961).
May 11 2023 at 9:16pm
Mark: But neither NAFTA nor USMCA required a common external tariff. Rules of origin were a sort of substitute, if that is what you mean.
May 10 2023 at 12:05pm
I think a more productive standpoint is just to accept that as of the time of the analysis there are many state imposed restrictions on imports (and some on exports, too, but they tend to be for “non-economic” reasons. Removing many if not all of these would improve economic welfare, but the benefits of the import restrictions are concentrated and the costs diffused throughout the polity. A “secret weapon” of reformers is that (because of the Learner effect) a lot of the costs are concentrated on exporters (and potential exporters, but they may not count for much politically). Other countries face similar problems. This means that one political tactic is for countries to come together in a trade negotiation that mobilizes each country’s exporters to favor reducing import barriers is their country in return for other countries reducing import barriers in theirs. [Of course in theory exporters could organize to push for unilateral reduction of import barriers but that doe not see to happen.]
May 11 2023 at 3:16pm
Thomas: We can see in the WSJ piece that “the secret weapon” does not work, although it seemed to work (for the wrong reasons) for six decades after WWII. With unilateral free trade, Honk Kong did not need it.
May 11 2023 at 1:30pm
Of course the history of this seems to be fairly well entrenched. Of note in Federalist 11, Hamilton, my least favorite founder, not Madison,
“The Federalist Papers,” specifically in Federalist No. 11, Hamilton argued that one of the benefits of the union was that collectively, and yes, I can feel the cringe over the internet just using that word!, they could negotiate better trade deals.
“If we continue united, we may counteract a policy so unfriendly to our prosperity in a variety of ways. By prohibitory regulations, extending, at the same time, throughout the States, we may oblige foreign countries to bid against each other, for the privileges of our markets.” — https://avalon.law.yale.edu/18th_century/fed11.asp
Of course I am not a proponent of this being unabashedly in favor of #nationaldivorce, but I did think it of note that this kind of argument has been made since the founding of the regime.
May 11 2023 at 3:08pm
Craig: Thanks for this contribution, but… Do you think that Hamilton was thinking about the future Chicken Tax? If not, why not? Had he understood Adam Smith correctly? I think my post “Why the Chicken Crossed the Road” is relevant. A (coercive) policy proposal must at least take reality as it is.
May 11 2023 at 6:03pm
Well, I asked ChattyG if he thought Hamilton would be caught dead in a Toyota Tacoma and Chatty said ‘no way’ and who can argue with that, right?
Hamilton is not necessarily dogmatic, he’s young, brash and in 1787 he would’ve been 30 years old, he dies in a duel of course. Who listens to 30 year olds? I mean, I’m 50 and I’m pretty sure the voting age should be 49 now, right? 😉
I know of two Hamiltons on this. One of them is the Hamilton who is Secy of the Treasury and he tends to advocate for a revenue tariff, at a time when there is no income tax. And if you follow the logic of Federalist 11 his vision there is the thought America would remain an agriculture country, but of course he would write the Report on Manufacturers which would be the intellectual boostrap for Cardozo to find that General Welfare Clause was an independent source of substantive power, but he definitely discusses balancing the revenue tariff with the protective tariff which definitely has a pro manufacturing outlook and I can attest to visiting Hamilton’s statue overlooking the Great Falls at Paterson, NJ where the SUM (Society for Useful Manufacturers) began America’s first planned industrial city.
Do I think he was thinking of protective tariffs when he wrote Federalist 11? No.
May 12 2023 at 3:58pm
“Had he understood Adam Smith correctly?”
This question presupposes that he read Wealth of Nations. Written in March 1776, its possible Hamilton read it, possible he even understood it but just adhered to his mercantalist leanings. Not sure, I personally have no recollection of Hamilton referencing Adam Smith in quite the same way I recall Madison referencing Vattel in one of his letters.
As an aside I did ask my new buddy ChattyG and he says:
“Craig: Did Alexander Hamilton read Wealth of Nations?
ChatGPT:There is no definitive evidence to suggest that Alexander Hamilton, one of the Founding Fathers of the United States, read “The Wealth of Nations” by Adam Smith. The book was published in 1776, the same year as the American Declaration of Independence, which suggests that Hamilton may have been aware of Smith’s work. However, there is no direct record of Hamilton referencing or mentioning “The Wealth of Nations” in his writings or correspondence. Hamilton’s economic ideas and policies were more closely aligned with the principles of mercantilism rather than the laissez-faire capitalism advocated by Adam Smith.”
Not sure how much weight you would give to that, but it definitely fits into the time budget I have to explore such an inquiry, I suppose! Perhaps you have some personal insight into Hamilton’s thoughts on Adam Smith?
May 12 2023 at 4:09pm
Nothing like doom scrolling on a Friday afternoon, right?
Ok, so my curiosity led me to ask the following question:
“Who was the first American to cite Adam Smith’s Wealth of Nations?”
“The first American to cite Adam Smith’s “The Wealth of Nations” was most likely Alexander Hamilton himself. In his “Report on Manufactures” submitted to the U.S. Congress in 1791, Hamilton referenced and drew upon the ideas presented in Smith’s work. Although Hamilton’s economic philosophy differed from Smith’s laissez-faire approach, he acknowledged the significance of Smith’s ideas on economic growth, division of labor, and the role of government in supporting industry. Hamilton’s citation of “The Wealth of Nations” played a role in introducing Smith’s ideas to the American context and influenced economic debates in the early years of the United States.”
I have read the Report on Manufacturers but more from the legal point of view, ie as the intellectual foundation for allowing the federal government to rely on the General Welfare Clause as a general delegation of substantive power. So now I do have a reason to re-read it more with a discerning eye towards how Hamilton may have incorporated Smith’s ideas into the report