The Great Trade Debates and What's at Stake
Remarks before the World Affairs Council and Texas International Trade Alliance
Oct. 10, 2000
Most of my too-many speeches
lately have been about our New Economy or, as we at the
Dallas Fed call it, our New-Paradigm
Economy. About how a surge in high-tech investment beginning
about five years ago has raised productivity and output growth
to new highs and reduced unemployment to new lows. About
how increased global competition combined with technology
to make our stronger growth and lower unemployment less inflationary
than in the past. My optimism about our New-Paradigm Economy—bordering
on exuberance, rational exuberance—has led some people
to call me the Fed's New-Paradigm Optimist.
I plead guilty. I might say, however, that my optimism
continues to be rewarded. This economy has been tough on
pessimists. Last Friday, for example, we learned that employment
growth last month was a vigorous 252,000 and that the unemployment
rate declined to 3.9 percent, matching its April low, which
was the lowest in about 30 years. Adjusted for changes in
the composition of the labor force, 3.9 percent may be the
lowest rate ever.
The national decline from 4.1
percent to 3.9 percent in the overall unemployment rate
included a full percentage
point decline in black unemployment, to 7 percent—the
lowest level in history. Latino unemployment is close to
Of course, as unemployment declines, other good things
happen. Declining unemployment facilitated successful welfare
reform and helped reduce crime and improve health.
We just learned last week that
household incomes rose 2.7 percent faster than inflation
last year to a record high
of $40,816. The official poverty rate fell to 11.8 percent,
the lowest in 11 years. That's because the average income
of the bottom fifth of households rose 4.4 percent last year—the
bottom 20 percent.
I don't know whether to quote
Buddy Holly saying "Rave
On" or Robert Earl Keen saying "The road goes on forever
and the party never ends." Or perhaps, Alan Greenspan saying "The
economy appears to be benefiting to an unusual but measurable
degree from structural adjustments and improvements either
set in motion by or resulting to a significant degree from
policy adjustments made in an earlier time frame."
I just made that up. That New-Paradigm Economy I described
earlier is Alan Greenspan's economy. God bless Alan Greenspan.
Back to my being a New Paradigm
optimist. Naturally, that means that after every speech,
about the first question I'm
asked is, "What do you worry about? What trouble is on the
horizon?" In other words, what is the optimist most pessimistic
I don't like to play the forced
pessimism or hypothetical-pessimism game because the "hypothetical" part
often gets lost in the translation. Let's just say I'm
somewhat less optimistic
about two things: in the near term, energy prices; in the
longer term, losing our nerve on free trade.
My story of faster growth with lower inflation since the
mid-1990s has suffered from a little inflation creep over
the past year. So far, it's been modest and primarily due
to higher oil and gas prices. The overall CPI, which includes
energy, has risen 3.4 percent over the past year. The core
CPI, which excludes energy and food, has risen only 2.5 percent.
The core PPI was up 1.5 percent.
My longer term concern has to
do with our apparent loss of nerve—and momentum—on
freer trade. Growing sentiment away from freer trade and
investment appears to
be related to an even broader questioning of the merits of
global capitalism by a small but loud minority that appears
to be intimidating trade policymakers. Without elaborating
on that, let me just remind you of Seattle last year.
It's ironic and mystifying that anticapitalist calls for
protectionism and socialism should come so soon after both
failed so miserably and visibly and free market capitalism
won the battle of the isms. Free enterprise is not only the
best creator of wealth but is the only system compatible
with individual liberty. But before I get any deeper into
this longer term concern, let me return briefly to energy
I know the energy capital of the world may not be the best
place to worry out loud about high energy prices, but duty
calls and my views have evolved somewhat.
People were conditioned in the 1970s to view sharply rising
energy prices in the context of supply cutbacks by OPEC.
Such price hikes are inflationary, and they also threaten
recession. The dominant impact depends on monetary policy.
Easing policy to avoid recession may increase inflation.
Tightening policy to avoid inflation increases the risk of
recession. That's the bad news on supply-induced price hikes.
The good news is that cartels break down because the members
have an incentive to cheat when they have excess capacity.
OPEC and other major producers finally seem to realize that
price hikes can be overdone and moderation has its merits
for the longer term.
Recent price hikes don't fit the old pattern well. They
had as much to do with demand growth as with supply restrictions.
Indeed, supply has continued to grow, although not as fast
as in a free market. Demand growth has coincided with a sharp
Asian recovery, stronger European growth and still-strong
North American growth. Limited refining capacity and low
inventories have contributed and make it easier for the cartel
to hold together.
Demand-pull energy price increases are more likely to remain
higher longer and raise the risk of inflation relative to
recession. As the comedian Dennis Miller says, of course,
that's just my opinion. I could be wrong.
Futures traders think I'm wrong, and I hope they're right.
They have prices declining sooner rather than later.
While I'm on the subject, let
me just mention that energy prices constitute one of two
differences in the pressures
on the U.S. and Texas economies. Higher energy prices are
a headwind for most of the country but are still a tailwind
for Texas—especially Houston.
Another difference, although
less important, has to do with our strong dollar. It's
good for all consumers but is
a mild headwind for producers and exporters. That's less
true for Texas—the headwind part—because Texas
exports are heavily weighted toward Mexico, which has a booming
economy fueled by high energy prices.
A footnote on Mexico: I was in Mexico City last week, visiting
with the governors of their central bank. They're very interested
in the U.S. economy because Mexican trade is even more concentrated
with us than ours is with them.
Texas is still a net beneficiary of high energy prices,
but diversification makes the net benefit less than it once
was. Airlines with Texas hubs are hit heavily, as is the
petrochemical industry, which uses natural gas as inputs.
Poor profits, poor cash flow and excess capacity have discouraged
construction of new chemical plants on the coast, contributing
to a decline in heavy construction in Texas.
Turning to trade, NAFTA has been a huge success. Trade
has increased enormously in both directions, and no sucking
sounds have been heard. That makes it doubly a shame that
fast-track authority to expand NAFTA to Chile and perhaps
other countries was denied. We also seem to have lost steam
in our drive to make the Free Trade Area of the Americas
(FTAA) initiative happen. The Seattle fiasco not only contributed
to the failure to initiate a new round of trade liberalization,
but the window breakers spouting nonsense seemed to have
had some success.
Meanwhile, while we dawdle, Mexico has reached a free trade
agreement with the European Union, which is also courting
Mercosur, a customs union in South America. Within Mercosur,
there's talk of a South American trading bloc negotiating
as a bloc with the United States, NAFTA and the European
Union. They are worried about unfair competition from the
superpower. If protectionist winds are not blowing in Latin
America, there's at least a breeze.
We need universal, worldwide free trade and free trade
with the other planets, not free trade within regional blocs.
NAFTA is consistent with universal free trade because it
reduced trade barriers among its members without raising
barriers to others. In contrast, Mercosur, like the European
Union, is a customs union with common external barriers and
is thus less compatible with worldwide free trade.
An interesting new development in trade relations is discussed
in an article that our Senator Gramm wrote for The International
Economy magazine, titled "Why Britain Should Join NAFTA." His
opening paragraph reads as follows: "Unfortunately, the world
is evolving not toward free trade, but toward regional trading
blocs that are becoming more protectionist. And nowhere is
that more true than in the European Union."
Senator Gramm points out that
the most recent members of the European Union had to raise
their tariffs to join. His
article is written in the context of Britain's future decision
on whether to join the Euro zone. He says that "choosing
a common currency means joining a country, and choosing a
country means choosing values ... a political and economic
A critic said the senator's proposal would result in the
British Isles becoming a satellite of America at the mercy
of American pressure groups and their congressional stooges.
Coming to the senator's defense
was one Winston S. Churchill, former member of the British
Parliament and grandson of you-know-who.
His response to Senator Gramm's critic was as follows. These
fears, he wrote, "are belied by reality."
Is the Mexican legislature
subordinate to the Congress of the United States?
Is Canada under relentless pressure
to join the almighty U.S. dollar? Are these two fiercely
independent nations, by fact of their membership of
NAFTA—a voluntary treaty, from which they can
withdraw at any time, unlike member states of the EU—subjected
to a relentless bombardment by regulations from Washington?
Of course not. Not only does the United States not
dominate its neighbors in these ways, it harbors neither
the intention nor the desire to do so.
Sadly, the same cannot
be said for the EU, whose high functionaries seem
to be inspired by a 1950s Kremlin
mentality. No fewer than 26,000 regulations and directives
drafted in Brussels—not amendable by our national
Parliament—now have the full rigor of British
Senator Gramm has performed a valuable service by
reminding us that there may indeed be an alternative
to the officious, protectionist, union-dominated, anti-democratic,
socialist-minded Europe that threatens both our prosperity
and our liberties.
That's the end of the quotation from Mr. Churchill.
Not all news is bad news on the trade front. Congressional
approval of permanent normal trade relations with China was
a hopeful sign. So was the recent expansion of H1-B visas
for skilled immigrants needed for our high-tech industries.
I heard a country song recently
by Sara Evans, who sang, and I quote, "He changed my mind with three chords and the
truth." Naturally, when I heard that line, I thought of the
difficulty economists have convincing skeptics of the merits
of free trade. They've had the truth ever since Adam Smith
published The Wealth of Nations in 1776, but apparently
they haven't found the right three chords to change resisting
If economists made a list of the things they agree on,
free trade would be at the top of the list. Unfortunately,
economists don't talk much about what they agree on. They
only debate their disagreements at the margin. That leaves
the public and their congressional representatives with the
impression that since the professionals don't agree, their
instincts are as good as any on the subject.
That's dangerous because of the fallacy of composition,
which you get into when you generalize from personal experience.
What's true for the individual is rarely true for the nation
as a whole. For example, money represents wealth for its
individual owner but not for the nation as a whole. That
was the point of Smith's Wealth of Nations, which
was an argument against the mercantilist protectionists of
his time and an argument for free trade, both internal and
One problem with the arguments for free trade is that its
benefits are diffused among the many and its harm is concentrated
among the few. Those harmed by freer trade are fewer in number,
but they know who they are. The many who are helped are generally
helped less, and they don't know what they have at stake.
It's an ideal situation for political pandering and demagoguery.
One of the most troublesome fallacies making free trade
a hard sell is the fallacy that it causes job losses. It's
true that some jobs are lost and that other jobs are created.
The jobs lost will be those that existed because of protection
in areas of comparative disadvantage. Those gained will be
those in areas of comparative advantage. The greater specialization
coming from trade will increase total output in both trading
nations. If society chose to do so, it could compensate the
losers with the gains of the winners and have much left over.
Freeing up trade doesn't change the number of jobs; it
changes the mix of jobs, for the better. It's an oversimplification,
but assume that increased imports cost jobs in import-competing
industries. And assume that increased exports create jobs
in export industries. The thing to remember is that exports
and imports change together and produce nearly offsetting
changes in jobs.
When we import more, other countries have more money to
buy our exports. When we export more, we get more money for
imports. Exchange rates will adjust to keep those flows approximately
the same. If exchange rates are fixed, the governments involved
will have to provide compensating finance to maintain the
One problem is that much of international trade theory
and much of economics in general is counterintuitive. A wise
man once said that if economics made sense, we wouldn't need
economists. Much of it seems not to make sense.
For example, Abraham Lincoln
was a very good amateur economist, as I will show later.
But he wasn't good enough to get international
trade right. Here's what he is supposed to have said about
tariffs: "I don't know much about the tariff, but I know
this. If I buy a coat in England, I get the coat and England
gets the money. If I buy a coat in America, I get the coat
and America gets the money."
Every cab driver in the world would agree with that statement,
but it's wrong. What Mr. Lincoln failed to consider was that
when he bought the coat in England, someone in England would
spend the proceeds in America, possibly on Texas cotton to
make the coat. The bucks don't stop. You can't have one-way
trade. If other countries won't buy from us (or lend us money),
we can't buy from them. If we won't buy from them, they can't
buy from us.
If we impose tariffs or quotas
on steel imports, we may be helping a steelworker, but
it will be at the expense of
other U.S. workers—possibly farmers—who won't
be able to export because the foreign country couldn't sell
its steel here.
To protect some workers is to harm others. The problem is
those protected know who they are and what they have at stake.
The person harmed has no clue. Which one will be writing
The most effective rhetoric
against protectionism in the history of the world was used
by my hero Frédéric
Bastiat, who was a self-taught economist and a member of
the French Parliament in the 1840s. Bastiat wrote—tongue
in cheek—a petition to the chamber of deputies on behalf
of the French candle makers wanting relief from the unfair
competition of the sun. Listen to this:
From the manufacturers of candles, tapers, lanterns,
candlesticks, street lamps, snuffers, and extinguishers,
and from the producers of tallow, oil, resin, alcohol,
and generally of everything connected with lighting.
To the honorable members of the chamber of deputies
You are on the right track. You reject abstract theories
and have little regard for abundance and low prices.
You concern yourself mainly with the fate of the producer.
You wish to free him from foreign competition, that
is, to reserve the domestic market for domestic industry.
We come to offer you a wonderful opportunity for
We are suffering from the ruinous competition of
a foreign rival who apparently works under conditions
so far superior to our own for the production of light
that he is flooding the domestic market with it at
an incredibly low price....
Bastiat is referring, of course, to the sun. He asks for
a law requiring the closing of all windows, dormers, skylights,
inside and outside shutters, curtains, etc. Virtually all
industries in France would benefit. There would be enormous
multiplier effects, creating many new jobs and improving
the national defense.
When I moved to Texas almost 10 years ago, the superconducting
supercollider was just beginning construction. From reading
the newspapers, I couldn't figure out what it was supposed
to do. All the emphasis was on the number of jobs it was
going to create. It may have been a good idea. But if it
was, it shouldn't have been sold as a job creator.
My wisdom on jobs is this: If you want more jobs, replace
all the bulldozers with shovels. If that doesn't get you
enough, replace the shovels with spoons.
No, jobs are too important to waste. You shouldn't count
jobs; you should make jobs count.
Actually, economic progress
can be measured by job losses. It once took almost 90 percent
of our population to grow
our food. Now we grow more food with less than 3 percent
of the population. Was that progress? Not if you measure
progress by the job count. Progress is measured by productivity—output
per hour worked—not by how many hours were worked.
What happened to farming yesterday is happening in manufacturing
today. U.S. manufacturing today is very healthy. Its productivity
is growing by leaps and bounds. That means that job growth
in manufacturing is not keeping up with output growth. But
that's a good thing. That's productivity growth.
The new jobs not being created
in manufacturing are being created in our growing service
sectors—in our new information/knowledge
Back to free trade rhetoric. After Bastiat's, the next-best
free trade rhetoric I've found comes from Henry George, who
is alleged to have said that protectionists want to do to
their country in peacetime what the country's enemies want
to do to it in wartime: shut its borders to imports.
The arguments against free trade are similar to arguments
against new technology. Both trade and technology offer you
more total output. Both involve many winners winning a little
and a few losers, each potentially losing more. In both cases,
their enemies know who they are, but not their beneficiaries.
Listen to this letter, written by Martin Van Buren, the
governor of New York in 1829, and see if it doesn't ring
January 21, 1829
To: President Andrew Jackson
The canal system of this
country is being threatened by a new form of transportation
known as "railroads." The
federal government must preserve the canals for the
One. If canal boats are
supplanted by "railroads," serious
unemployment will result. Captains, cooks, drivers,
hostlers, repairmen and lock tenders will be left without
means of livelihood, not to mention numerous farmers
now employed in growing hay for horses.
Two. Boat builders would suffer and towline, whip
and harness makers would be left destitute.
Three. Canal boats are absolutely essential to the
defense of the United States. In the event of the expected
trouble with England, the Erie Canal would be the only
means by which we could ever move the supplies so vital
to waging modern war.
As you may well know,
Mr. President, "railroad" carriages
are pulled at the enormous speed of fifteen miles per
hour by "engines" which, in addition to endangering
life and limb of passengers, roar and snort their way
through the countryside, setting fire to crops, scaring
the livestock and frightening our women and children.
The Almighty certainly never intended that people should
travel at such breakneck speed.
Martin Van Buren
Governor of New York
I said earlier that Abraham Lincoln was a pretty good amateur
economist, although not good enough to get trade right. I
thought of him when I read about the window breakers in Seattle
who wanted, among other things, to help the plight of poor
people in poor countries by refusing to trade with them.
By not trading with them, we're somehow going to improve
their environment and reduce the problem of child labor.
Somehow, the problems of the world are caused by large corporations
that employ people and by the free enterprise system that
has produced unheard of wealth.
Instead they want the system
that North Korea chose and left South Korea to languish
in free enterprise. They prefer
the advantages that East Germany had over West Germany. They
want the pristine air and water found in the parts of the
world not sullied by raw capitalist development—places
like the former Soviet Union and Eastern Europe.
I don't have a clue how to argue with that kind of logic,
the logic that has college kids all over the world trying
to help child workers by taking their work away and their
parents by refusing to buy their goods. I suppose parents
in poor countries are not good parents. They need our moral
superiority and guidance. We need to remove their temptation
to let their children work by removing the market for the
fruits of their labor.
As I said, for some reason I think of the economic wisdom
of Abraham Lincoln when I think of the window breakers in
Seattle and the trashers of McDonald's in Europe.
I'll close with Honest Abe.
Economic Principles of Abraham Lincoln
You cannot bring about prosperity by discouraging
You cannot strengthen the weak by weakening the strong.
You cannot help small men by tearing down big men.
You cannot help the poor by destroying the rich.
You cannot lift the wage earner by pulling down the
You cannot keep out of trouble by spending more than
You cannot establish sound security on borrowed money.
You cannot build character and courage by taking away
a man's initiative and independence.
You cannot help men permanently by doing for them
what they could and should do for themselves.
Courtesy of the Clint W. Murchison, Sr.,
Chair of Free Enterprise, University of Texas
About the Author
McTeer is chancellor of The Texas A&M University System and former president and CEO of the Federal Reserve Bank of Dallas.