Business

The United States Of Free Trade

In 1824 the Supreme Court held protectionist state laws unconstitutional. Wild prosperity ensued.

The Constitution requires free trade, the US Supreme Court held in 1824. In Gibbons v. Ogden, the state of New York had awarded a monopoly in its waters to Robert Livingston and Robert Fulton for the emerging technology of steamboats. Further, the state had defined New York waters as running to the high-tide mark in neighbouring states. Thomas Gibbons, who ran a steamboat between New York and New Jersey, sued.

The court ruled unanimously against the monopoly, declaring that the power to regulate interstate commerce lay exclusively with the federal government and that states couldn't impose impediments to that commerce in their parochial self-interest. The economic effect of the ruling was immediate. In one year the number of steamboats operating in New York waters rose from six to 43, while fares fell by 40%. Charles Warren, the great historian of the Supreme Court, called Gibbons v. Ogden "the emancipation proclamation of the American economy."

The case made the US the world's largest free market by flattening state-imposed barriers to "commerce," a word the court had defined broadly to include trade and navigation.

Within a half-century, the American economy rose to become the mightiest in the world, due in no small part to the precedent created by that decision. The reason is simple enough. Free trade allows maximal use of "comparative advantage" to minimise the price of goods for everyone. The lower the prices, the higher the demand and thus the larger the economy.

If T-shirts, for instance, can be made more cheaply in Bangladesh, thanks to low labour costs in that country (and the price of a T-shirt is determined mostly by the labour input), then it makes little economic sense to manufacture them in New York City's Garment District.

Equally, the US can make far better movies than Bangladesh, thanks to Hollywood's unmatched infrastructure and talent pool. So the US sells Bangladesh movies and buys its T-shirts. Both nations are better off. Both are richer because of the trade.

With its own example of the power of free trade to produce wealth for everyone, one would think that the US would have promoted it world-wide. But for most of the country's history, Americans have been anything but free traders beyond their own borders. Instead the federal government used high tariffs to protect American industry even long after it had become more efficient than European industry. Only when US tariff policy produced disaster did Washington change its ways.

In 1930, hoping to safeguard the American domestic market for US producers in the looming Depression, Congress passed the Smoot-Hawley tariff, the highest in American history.

Despite the pleas of more than 1,000 economists, President Herbert Hoover signed it into law. The results were catastrophic. With the US erecting higher tariff walls to protect its internal market, other countries naturally did the same in a game of beggar-thy-neighbour. American exports fell from US$ 5.241 billion in 1929 to US$ 1.161 billion in 1932, a 78% decline. World trade in that period declined from US$ 36 billion to US$ 12 billion - less, adjusted for inflation, than it had been in 1896.

After World War II, much of the world economy was in shambles. The US, having learned its lesson, moved to lower tariffs worldwide. In 1947, 23 nations signed the General Agreement on Tariffs and Trade and began negotiations to lower tariffs, which then averaged 22%, as well as other barriers to trade. In a series of seven negotiations, involving more nations as colonies became independent and the Soviet empire collapsed, the average tariff had been lowered to only 5% by 1999. Today there are only a handful of countries that aren't members of the World Trade Organization, successor to the GATT.

The results of this long and often arduous process have been spectacular. World trade has increased exponentially. Merchandise trade amounted to about US$ 58 billion in 1950. By the end of the century it was US$ 5.4 trillion. Only 17 years later, merchandise trade had increased to US$ 17 trillion. Trade in agricultural products and services has increased similarly.

Even taking inflation into account, world trade since World War II has increased by a factor of about 30, making the whole world vastly more prosperous.

To be sure, the spike in trade-and prosperity-can't be attributed entirely to the reduction in tariffs. New technologies and better trade policies were mutually-reinforcing. The development of the shipping container, for example, greatly reduced shipping costs beginning in the 1950s.

What prevents the world from becoming a total free trade zone, as the US has been for almost two centuries? Start with domestic politics: The handful of American sugar producers, for instance, exert a powerful influence on Congress, which protects the domestic industry with quotas. As a result, Americans pay much more for sugar (and everything that contains sugar) than the world price.

Strategic considerations are also an obstacle to a global free trading system. Great powers such as the US must maintain domestic sources of supply for vital war material, such as steel and jet aircraft.

Then there is the persistent though discredited belief that countries should strive to maintain a positive balance of trade, with more exports than imports.

It is, of course, no more possible for all countries to have a positive balance of trade than it is for all people to be above average in height.

Rapidly growing and maturing economies usually run foreign trade deficits, as the US did throughout the 19th century while it grew into an economic superpower. The US is again running large trade deficits, but those deficits are balanced by large capital inflows from foreign investors.

Totally free international trade probably isn't possible in a world made up of sovereign nation states. There is no court that could hand down a global Gibbons v. Ogden. But it should be treated as an economic ideal that the nations of the world aspire to, even if they can never quite reach it.

(Wall Street Journal)