Straight Talk On "Free Trade"


There's been a lot of talk about "free trade," or more accurately, cross border trade, in this election cycle, and as a card carrying refugee from one of those industries that was boxed and shipped overseas, I think a dose of reality might be in order.

First, it is important to understand that the single greatest cost in the manufacturing process is labor. Human beings are costly things in the manufacturing process, and that's mostly they lack the efficiency of machines. It should come as no surprise that companies that make products will seek to reduce this cost by any means necessary, and that includes mechanization, or a lower cost work force. This process has been in place since the beginning of the industrial revolution, and people are acting as if this was invented in 2008. It has never stopped, and it is relentless. There is a great deal of hypocrisy here (as there is with immigration, but that's another story) as decades ago, businesses within the United States moved away from costly urban centers to office parks and factories in cheaper, rural areas. Oddly, there was no outcry then, but the urban areas managed to adapt by concentrating on more technocratic fields of endeavor. However, it was only a matter of time before this applied to the movement of production from rural areas in the U.S. to overseas. Then the flags came out.

What is lost in the discussion of these “bad trade deals” we supposedly made is that they weren't executed to cost us jobs- they were designed to prevent us from losing more of them, or at least slow down the process. In the earlier days, the apparel and textile industry had an elaborate set of quota categories that couldn't be exceeded by importers. In typical bureaucratic fashion, under the rules of the “Multi Fiber Agreement,” for example, there were no less than 16 categories of denim alone. Another 41 categories of yarns. The Agreement on Textiles and Clothing had a truly byzantine structure of finished products- there were quotas for handbags with straps, handbags without straps, leather handbags with straps, leather without, and... you get the idea. However, the quota apparatus soon developed, in typical free market fashion, into its own “cap and trade” system. Manufacturers who had purchased quota at the beginning of a season and had no orders to use them, simply sold them to other manufacturers who did, often at a great profit. Once people saw that, speculators who had absolutely no intention of manufacturing any product simply purchased quota at the beginning of a season and bet the price would go up to be sold to desperate manufacturers whose production had exceeded quotas and couldn't ship millions in finished goods without them. They paid dearly for this system of arbitrage. Later, nations that couldn't fill their allotted quota (Vietnam) simply subcontracted for nations that could (China) and with the product origin identified by little more than a neck label, there was work for all. An elaborate bureaucracy for enforcement was set up to prevent this. Many were caught. Many more got away with it. The rules weren't working, and the complex system of agreements soon frayed. In the end, no domestic manufacturer could compete.

From a 2005 Wharton report:

"When import quotas on textile products coming into the United States ended January 1, 2005, under World Trade Organization agreements signed 10 years earlier, a flood of clothing poured in from China. Within months, the U.S. responded with restrictions on Chinese apparel imports. Yet according to Wharton faculty and industry executives, these restrictions will only delay, not end, the global move toward quota-free garment trade.

While some large U.S. textile makers are opposed to the removal of quotas, the overwhelming majority of U.S. clothing manufacturers and retailers produce the bulk of their products overseas and support the elimination of all restrictions on imports. This group anticipated that the end of the 30-year-old quota system would not be entirely smooth, and in fact were braced for the latest restrictions, known as safeguards under the WTO agreement."

And from a United Nations report:

“On 1 January 2005 the United States, Canada and the EU eliminated a system of bilateral quotas on imports of textiles and apparel established by the ATC of the World Trade Organization (WTO) during the period 1995–2004. While these quotas were welfare reducing for the residents of these areas, they also had the effect of stimulating exports of textiles and apparel from a number of developing economies that might otherwise not have participated in those import markets. This effect is “trade diversion,”for the importing countries and a growth stimulus for the developing country exporters. There is also the potential for “trade deflection” and “trade destruction.” Countries facing a binding quota from these areas will then either deflect their products to third countries or reduce their imports from third countries by substituting domestic production.”

Keep in mind this is just for apparel and textiles. It doesn't include appliances, computers, electronics, auto parts, or any of the myriad products involved in global trade. All of these agreements amounted to little more than a rear guard action against the inevitable, because ultimately, the low cost producer will win the customer. And anyone who thinks this can be prevented is kidding themselves.

In the meantime, it's not as if the world hasn't benefited. The free market capitalism we proclaimed as mankind's salvation has lifted well over a billion people in dozens of nations out of crushing poverty, hunger and want. It has provided political and economic stability in nations that hadn't known of such things for centuries. While that is scant comfort for someone who lost a factory job, the planet doesn't belong to us, and other people might want their day in the sun, too.

Even bringing back the manufacturing facilities will have little effect anyway: many processes have become so automated, the most highly skilled jobs have been eliminated for the same reason they went overseas: cost.

Instead of falling for a sense of aggrievement and resentment, Americans have to come to terms with the fact there is no going back to the post-war machine age prosperity we had when there was literally no competition from other countries, or automated manufacturing processes. The economic challenge for a prosperous and equal nation is indeed daunting, but the answers don't lie in nostalgia. We need to come up with a model that works in the world we actually live in.

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FloMartin Securities, Inc.

Donald R. Davret, Investment Advisor Representative

www.sec.gov

www.sipc.org

 

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