THE FREE TRADE 'MYTH'

June 1987 - Tokyo Business Today

Have you heard the Coca Cola argument for why the U.S. should not be upset over its massive trade deficit with Japan ? It goes something like this: True, Japan does sell much more to the U.S. than it buys. But when you add in the amounts that U.S. companies like Coca Cola and IBM produce in Japan, the trade figures almost balance. The monetary value of U.S. 'sales' to Japan equals its purchases. So no one needs to worry. For logic it is on a par with the argument that says the trade deficit does not harm the U.S. because Japan uses the money from its trade surplus to finance the U.S. fiscal deficit.

Don't the people who put forward these arguments realize what the trade war is about? It is not about money. It is about jobs and industrial survival. The U.S. can tolerate the outflow of trade dollars to Japan. What it cannot tolerate is the unemployment and loss of skills which have resulted from its one-sided effort to defend what it sees as the all-important principle of free trade. Only now is it finally beginning to move to defend its vital economist interest.

Why has the U.S. been so slow t move? Sometimes I think the very words 'free trade' are the key to the problem. They turn all debate into a motherhood issue. After all, who apart from the commies would want to oppose something based on freedom? If from the start there had been other words - something like law of the jungle trade aimed to suppress the weak and penalise the honest- the U.S. would not be in the mess it is today.

If I feel strongly on this issue it is because many year ago I had to beat my brains out trying to grasp the theories of academic economists 'proving' the virtues of free trade. One, devised a century or so ago, 'proved' how if Britain produced all the wool and Portugal produced all the wine both could live happily ever after exchanging their mutual surplus. It said no- thing about what would happen if the Portuguese one day decided they were tired of stamping grapes and they too wanted to have some nice shiny textile factories.

But the main problem was that the theories were based almost entirely on the concept of constant or diminishing returns. In this situation it can be 'proved' easily how free trade maximizes the welfare of both parties. But as any producer of semi-conductors can tell you, today we live in a world of increasing returns. In other words, the more I produce the lower, not the higher, my unit costs.

In this situation everything changes. Who produces what is decided almost entirely by who happens to get into full production first. If I have a slight lead in technology, or in get-up-and-go dynamism, or simply in ruthless willingness to protect my own market while exploiting your commitment to free markets, then I end up producing not just all the wool and all the wine but all the semi-conductors, the cars the CDs, the VTRs, the computers, you name it. Your role is simply to keep the printing presses turning so that my exporters get paid on time. You can also print a few extra notes to keep your unemployed from starvation.

This essentially is what is happening between Japan and the U.S. In theory the exchange rate is supposed to prevent things getting too one-sided. But as we see today, the exchange rate market works too slowly and haphazardly. By the time it starts to move decisively, Japan has already monopolized everything. Its export industries have to be dragged kicking and screaming to the brink of bankruptcy before they will ease up.

In this situation the U.S. should be much more ruthless than it has been. It should select the industries it needs, and protect them to the hilt if necessary. With imports kept out, enough U.S. producers will emerge to encourage competitive efficiency. And even if in some areas the U.S. can never match Japanese efficiency, this is not the end of the world. Japan gets by perfectly well by protecting inefficient areas of its economy. It realises better than we do that what it loses is more than covered by the gains from extra economic activity, lower unit costs and lower unemployment.

How come Japan is so smart? Well it has its academic economists too. But fortunately no one listens to them.

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