After Free Trade

Factory to the World

Robert E. Lighthizer

Any review that calls the book in question “captivating” and “clear-eyed” and that describes its author as the “most consequential U.S. trade representative of the last 30 years” cannot be all bad, and Gordon Hanson’s review of my book, No Trade Is Free, is no exception. I admire his scholarship on the impact of import competition on American communities, which I cite in the book. I only wish he could further undock himself from academic rigidity and allow current global economic realities to challenge old dogma.

No Trade Is Free lays out a vision for U.S. trade policy and details its implementation during the Trump administration. I believe trade policy should help working-class Americans find and maintain good-paying jobs. But for decades, it has instead centered on price optimization, efficiency, and corporate profits. The result has been the loss of millions of jobs, the destruction of thousands of communities, and the accumulation of trillions of dollars of trade deficits. This policy has made the country weaker and poorer.

The book also raises the alarm about the threat that the Chinese Communist Party poses to the United States. China is an increasingly aggressive, totalitarian, and hostile state that believes it should be number one in the world. It intimidates the U.S. military in international waters and space and challenges American diplomats around the world. It steals U.S. technology, engages in continual espionage, funnels fentanyl past U.S. borders, and effectively funds two proxy wars against the United States—backing Russia’s efforts in Ukraine and providing oil revenues to Iran that end up with Hamas. Worst of all, China has for decades waged an economic war that pulls in trillions of dollars of American wealth through trade surpluses. The Trump administration took on this challenge and set U.S. relations with China on a new course.

EXISTENTIAL THREAT

Curiously, however, Hanson’s review barely mentions the China-related aspects of my book. Indeed, China’s alarming rise has nothing to do with free trade or such fine notions as comparative advantage. Hanson’s oversight is important because every economic theory must be judged by this dangerous twenty-first-century reality—and every policy must be measured against this existential threat.

Hanson also makes several incorrect claims about my book. Perhaps most unfairly, he alleges that I take “liberties in interpreting the history of U.S. trade policy.” He claims that I ignore the role Republicans have played in encouraging free trade, but I do not. I clearly state, for instance, that the leaders of both parties pushed for the North American Free Trade Agreement and for “most favored nation” treatment for China. The book actually agrees with its critic that, as he writes, “the era of hyperglobalization was a genuinely bipartisan creation.” Hanson claims I “bizarrely” suggest that U.S. trade policy took a radical turn in the 1990s. He ignores the fact that the signing of the North American Free Trade Agreement, the creation of the World Trade Organization, and the granting of permanent “most favored nation” status to China—the trifecta of globalism—all occurred in the span of eight years. Indeed, Hanson begins his review by suggesting that “the era of hyperglobalization started in 1995, with the creation of the World Trade Organization.” One might think that he agrees with my bizarre interpretation.

Hanson states that I believe trade agreements should be judged by their effect on the trade deficit alone, but as I write in No Trade Is Free, under Trump, “the goal was increasing the number of high-quality jobs.” Hanson criticizes me for wanting trade deals to increase exports but not imports. Yet that is exactly how every administration has sold trade deals to Congress and the public. If the objective was otherwise, why negotiate a deal? Any country can unilaterally increase imports. But of course, few do.

For decades, trade policy has centered on price optimization, efficiency, and corporate profits.

Hanson accuses me of neglecting the U.S. trade surplus in services, but the reality is those surpluses offset only a fifth of the $1.2 trillion goods deficit. They are important but insufficient to power the U.S. economy and create enough high-paying jobs for American workers. He says that the Reagan-era limits on Japanese car imports were a failure, but it was precisely because of this policy that Japanese car companies brought their manufacturing to the United States and now employ thousands of American workers.

Hanson agrees that raising tariffs will reduce imports, but he asserts that “they also tend to reduce exports, because factories then focus on making goods for domestic consumers.” Surely, that is only true if one assumes the United States has full employment and is operating at full industrial capacity. Neither of those conditions holds true. Tariffs could also lead to new manufacturing.

Hanson repeats the trope that Trump’s China tariffs increased prices, but the United States had less than two percent inflation during the president’s tenure. He also makes the free traders’ argument that the trade deficit expanded during the Trump years. In fact, before the COVID-19 pandemic, the deficit with the world was down in four of the previous quarters, and the deficit with China was down in the previous five straight quarters. But that all changed when the pandemic closed the economy and forced the release of trillions of dollars in stimulus. It takes time to right the ship, but the Trump administration had corrected its trajectory.

MORE THAN ECONOMICS

Hanson goes most astray, however, when he argues that focusing on the restoration of American manufacturing is misguided because “the United States has little comparative advantage in most areas of manufacturing.” Hanson contends that “the future of American prosperity lies in the service sector, not in the furnaces and assembly lines of the past.” But this is a false choice: the country can and should have both.

Comparative advantages are not necessarily inherent in a country, as he assumes. They can be created, usually through industrial policy, subsidies, and trade restrictions. South Korea is competitive when it comes to making steel, but it does not enjoy cheap power, iron ore, or other natural advantages in this sector. Its comparative advantage is entirely the result of government policy. The same can be said of Taiwan and semiconductors. The Taiwan Semiconductor Manufacturing Company today has a comparative advantage, but it was created by subsidies and tax breaks. The airplane manufacturer Airbus is very competitive, but that is entirely because four European countries got together, spent billions in subsidies, and created a world-class company. The same, of course, could be said historically about many manufacturing sectors in the United States, as well as in Germany, Japan, and the United Kingdom. Indeed, it is difficult to find an example of a great manufacturing economy that did not create much of its comparative advantage through state intervention.

Further, manufacturing is about more than economics. It is about the kind of country that Americans want. The allocation of scarce resources, price optimization, and efficiency—things that preoccupy economists—are not as important as issues of family stability, strong communities, income equity, and worker pride and satisfaction.

About two-thirds of American workers do not have a college degree. For many in this group, a manufacturing job, or one created by it, is a ticket to the middle class. These jobs generally pay better and offer more benefits than jobs in service sectors, such as health care, tourism, and hospitality. As Hanson himself notes, when manufacturing workers lose their jobs, “they tend to suffer a permanent decline in earnings relative to those who keep their positions,” and when enough manufacturing jobs vanish, “entire regions suffer.”

Maintaining a vigorous manufacturing sector is important for other reasons, too. First, there are obvious national security implications in relying on other countries, particularly hostile ones, for the United States’ defense and related needs. The pandemic offered a glimpse of these dangers. Once a war begins, it is too late to build manufacturing capacity.

Second, despite only accounting for around 11 percent of GDP, manufacturing drives 70 percent of American R & D investment; it employs as many scientists, engineers, and other so-called super-STEM workers as the much larger health-care industry and more than any other sector; and it accounts for 35 percent of annual increases in U.S. productivity. In fact, for every manufacturing job created, seven to 12 jobs are created elsewhere in the American economy. Manufacturing firms are also important customers for many of the high-value-added service providers economists so cherish.

Finally, let’s return to the question of China. The United States will struggle in a postindustrial world when its lethal adversary, bent on its demise, is the dominant manufacturer. Do the proponents of Hanson’s view really understand the nature of the threat China poses? These are the concerns that must shape a new economic theory. I appreciate Hanson’s review and hope that he and other top economists update economic theories to prioritize U.S. workers and communities and, most important, factor into their thinking the existential threat that is communist China.

Hanson Replies

As the possibility of Donald Trump returning to the White House grows, it is all the more important to pay attention to his top advisers, who are surely preparing an agenda for a second term. Robert Lighthizer, who played an outsize role as U.S. trade representative in Trump’s first term, is likely an influential voice on all matters related to trade and industrial policy. His reply to my review, like his book, is replete with insight. Yet it also contains several tendentious arguments that are worth putting under the microscope.

Lighthizer suggests that I, and presumably other economists studying globalization, should “undock [myself] from academic rigidity and allow current global economic realities to challenge old dogma.” I heartily agree. Indeed, those of us who first documented the profoundly adverse impacts of import competition from China on American workers were received poorly by think tanks, prominent academics, and The Wall Street Journal editorial page for casting free trade in a purportedly bad light. Such research helped reveal the dark side of globalization. Now, the public policy debate revolves around what to do about the downsides of free trade. As U.S. trade representative, Lighthizer concluded that the answer was to confront China, abandon the World Trade Organization, and raise tariffs on U.S. imports. But he was right about only the first of these three solutions.

Lighthizer argues that academics and think tankers have not taken the economic threat from China seriously enough. Here again, I agree. My review praises Lighthizer for calling attention to China’s many trade travesties. He is both scathing and thorough in cataloging China’s economic policy sins. But it is fair to ask whether U.S. efforts to punish China have worked. The United States is now six years into a trade war with China, which Trump began and U.S. President Joe Biden has eagerly continued. Rather than bowing to U.S. pressure, China seems ever more emboldened to aggressively pursue its nationalistic trade agenda. It is also fair to ask whether U.S. opposition to China would have been more effective had Trump acted in concert with U.S. allies rather than imposing tariffs on some of the United States’ most reliable trading partners, thereby wasting political capital. To date, the go-it-alone approach to China has borne little fruit. As Lighthizer prepares Trump for a possible redo of the presidency, he should reckon with the ineffectiveness of recent U.S. trade policy on China.

Core to Lighthizer’s reading of history is how he understands the origins of comparative advantage, a subject that may seem arcane but is at the heart of debates about U.S. industrial policy. A country or region has a comparative advantage in an industry if it can produce the associated goods more cheaply than its competitors. If market forces are left to themselves, comparative advantage tends to determine who exports what. Lighthizer suggests that comparative advantage is created and not inherited, which is partly true. Economists distinguish between the “first-nature advantages” of regions, which include the supplies of natural resources that fuel their initial economic development—think of how Pittsburgh, with its ready access to coal and iron ore, came to dominate the steel industry—and “second-nature advantages,” which regions acquire through experience and experimentation—think of Detroit’s use of Pittsburgh’s steel to make cars. Breaking with decades of GOP economic doctrine, Lighthizer contends that governments can readily conjure up second-nature advantages, citing Taiwan’s success in semiconductors as an example. In his telling, it was “subsidies and tax breaks” that turned the Taiwan Semiconductor Manufacturing Company into the world’s dominant chip producer. But the more likely cause was Taiwan’s massive investments in higher education in engineering. These investments directed the island’s technological progress generally toward electronics, with TSMC’s specific success being something of an accident. Getting industrial policy right depends crucially on whether governments should focus on cultivating industries, which requires identifying future TSMCs before they have become successful, or target talents, which means investing widely in human capital and then letting the chips, so to speak, fall where they may. Many economists have come around to supporting the second type of industrial policy, but not so much the first. Let’s hope for the sake of the American worker that Lighthizer closely follows the debates on the origins of comparative advantage and the limits of industrial policy.