''A trade policy that tries
to force free trade on the world
is doomed to failure-and
would ruin us if adopted!'

Any manager who tries to create a strategy out of worn-out cliches and unexamined nostrums
is dismissed. Yet in the United States and other Western countries we have grown comfortable with the
government following outworn nostrums about free
trade. We have elevated the economic theory of free
trade to the status of a national theology, and we follow
its simple dictums as if they were immutable laws. We
appear prepared to follow the precepts of free trade
wherever they lead us, even if that means plunging
lemminglike to our economic ruin.
Today the evidence should be clear to
anyone who wants to look at it: our blind allegiance to
free trade threatens our national standard of living and
our economic future. By sacrificing our home market
on the altar of free trade, we are condemning ourselves
and our children to a future of fewer competitive businesses, fewer good jobs, less opportunity and a lower
standard of living. These unacceptable outcomes
threaten us in ways tbat are all related to our practice
of free trade.
American business's stake in these matters is clear. If we do not wish to live with these outcomes, then we must construct a new and effective
way to think about trade that will serve the interests of
both business and the nation.

Threats of free trade
As we practice it, free trade has profoundly destructive results for the United States and
other Western nations. First, nations that do not play
by our rules practice unequal competition. Second, free
trade puts us in direct competition with low-wage nations, countries that have a lower standard of living

John M. Culbertson

The folly of
free trade
than the United States. Third, by allowing tbese nations to take over big sectors of our market, we permit
the permanent interruption of an important relationship between demand and supply that has been the
main engine of economic growth in American history.

Unequal national competition
Classical economics teaches us that
free exchange works to produce the best results for all,
whether the excbange takes place within one nation or
across national boundaries. But this concept works only when the exchange is an equal one that occurs within a common framework of laws, customs, rules, and
regulations. Economic competition conducted under
the law of the jungle leads to chaos and failure. The
price system becomes a guide to nothing that is sensible or tolerable.
The laissez-faire approach to economics
fashionable in the United States permits distorted outcomes precisely because it neglects the essential role
of rules and regulations in preventing destructive competition. When each nation creates self-serving rules,
free trade across national boundaries becomes destructive-an unequal competition under inconsistent and
inharmonious rules.
Most American companies facing international competition have encountered the problem.
Most governments are playing a simple game: they use
their myriad powers - subsidies, favorable banking
practices, local content requirements, exchange control, and the like-to win jobs and gain higher incomes
for their people or to acbieve a favorable national balance of payments.
American companies, therefore, end up
competing not with foreign companies but with sovereign foreign states-states intent on winning jobs and

most recently. workers. no one accepts or supports the notion of free immigration. workers from the lower-wage countries would stream into the higher-wage countries. As a result. in turn. we persistently fail to see the importance of our vast. deprived of its economic base. jobs to their people. the lower-wage nation enjoys only a short-term benefit. Rapid economic advance based on taking over the markets. market. those of the lower-wage nation would rise. Precisely for this reason. European nations have special treatment for the value-added tax on exported goods. and. These countries could not have risen so rapidly if they had based their advance on their home markets or on balanced and mutually beneficial trade with other nations. as Japan and other countries of the Pacific rim have taken over large shares of the . But in the United States. failures of companies. market a unique richness and diversity This market was the magnet that drew forth the new industries that. we are now ahout to give away our great advantage to our foreign competitors. prosperous. and the jobs of high-income nations is likely to be a blind alley.S. The process was selffeeding. they have taken over U. Most of the Pacific rim nations have weak or nonexistent environmental regulations. created even more wealth. 123 For example. Demand & markets Our present-day economics fails to recognize the importance of demand and markets-and thus exaggerates what production alone can accomplish. Instead of exporting workers to the United States.S. the higher-wage nation. extraordinary resources. Wage competition among nations Among nations. Gradually. competition over wages causes desirahle industries and jobs to move from countries with higher standards of living and higher wages to countries with lower standards of living and lower wages. 1984). South Korea have had rapid increases in desirable jobs in major industries and in their standards of living. and force the existing jobholders to accept either lower wages or unemployment. These new arrivals would compete for jobs. As the higher-wage nation suffers cutbacks in production. The result of either approach would be the same-our wages and standard of living would fall to match the level of the lower-wage nation while. becomes poorer and its market shrinks-or it helatediy begins protecting itself from one-sided imports. fohn Culbertson is professor of economics at the University of Wisconsin in Madison. He bas been an economist witb tbe Board of Governors of the Federal Reserve System and a consultant to the Federal Reserve Bank of St.S. and losses of jobs. They have gained industries and johs that we have lost. Japan grants favorable credit terms to certain industries. markets and jobs. Taiwan. We don't appreciate the key role that the demand side of our domestic market has played in generating economic growth for our country. which has the same effect. Foreign competitors are ahle to beat out a U. If there were free immigration and truly open borders. the industries. But recently this self-feeding interaction has been interrupted. company not because of superior economic efficiency but because of subsidies. Through unbalanced exports to us. of course. undercutting our production.S. It is an unequal form of competition that explains much of the recent movement of industries and jobs out of the United States. however. The low-wage nation then may wish it had followed a pattem of economic growth that was sustainahle and not parasitic.Free trade sometimes whole industries for themselves. He is tbeauthor of six books. Laborers in places like China lack the rights of U. freedom from overpopulation. a favorable position in the two world warsgave the U. Low-wage nations can raise their standards of living at tbe expense of ours in two ways: export their people to the United States or import U. Louis. Yet a nation's productive capabilities are decisively limited hy the levels and kinds of its domestic demand and its access to foreign markets. Favorahle circumstances-the size of the U. Japan. America's rise to economic preeminence was based on the interaction hetween tbe market's demand and the pace-setting industries that developed to meet that demand. lower-wage countries simply import our jobs and industries to their workers. In the interaction of demand and supply the U. including International Trade and The Future of the West (21st Century Press.S. accept work for lower pay. accept and support the notion of free trade. and many countries give cheap exportfinance loans. the market dictates that workers accept lower wages and a reduced standard of living to match the lower-wage foreign competition. economy became the pathbreaker for the world. pulled down by the negative-sum game of international wage competition.S. We dO/ however. Either free migration or free trade would work to tum the world into a "population commune/' drifting into global poverty. and Taiwan often fails to enforce its patent and copyright laws. at least temporarily.S. Under either free immigration or free trade. and accessihle domestic market.

U. Efforts to compete by cutting costs are suicidal.S. economists offer an example in which two nations with different wage and cost levels nevertheless have a pattern of trade that is balanced and mutually beneficial. decimating staff is a formula for self-destruction.S. al trade and competition. lower-standard-ofliving nation.S.S. market switched over to fueling the meteoric advance of foreign industries. by using government subsidies and lower-wage workers.S. we first need to examine these underlying notions. By reducing the value of the dollar we cut real wages. If the United States is to develop a realistic trade policy.S. this argument is fallacious. low-price nation cannot pull away the industries and jobs of the other nation. self-reinforcing process.S. With the U. First. laissez-faire economists from Adam Smith to the present have claimed that international trade and competition work totally differently from trade within one nation's borders. production at wages of $ 10 an hour can become competitive with efficient foreign production at wages of $ 1 an hour.S. As they undercut U. trade into balance is for American companies to compete by cutting costs. they say. it reflects wage and price competition on the part of countries seeking jobs and economic growth. oil industry is warning the nation that it is being forced to cripple its future capabilities by lowering costs to survive the flood of cheap foreign oil. Exchange rate adjnstments automatically keep foreign trade in balance. there is no way U. quite simply. The implicit argument is that a decline in the dollar would balance U. These nations have-recognized the role of demand in fostering industrial growth and.S. the new relationship that substitutes foreign industry for American industry represents an economic blind alley. Abandoning research and development. they will gradually. worth less. Under this condition. trade and improve the competitiveness of U. however. then the trade will be governed by comparative advantage and absolute price levels will not matter. The U. differences in the nations' absolute costs will not matter. To support this contention. that trade is not subject to the rule that low-priced goods undercut high-priced goods and that low-priced labor undercuts high-priced labor Rather. A devalued dollar is. Most of international trade is not governed by comparative advantage.S.weaken the American economic base that they have come to depend on. the low-wage. have simply substituted their industries for Ameriean industries in the demand-supply relationship. recognize them for the myths that they are. They argue that international trade and competition are not based on price comparisons-that is. They then say that the example shows how free trade will result in balanced and mutually beneficial internation- U. The domestic markets of these foreign producers have neither the size nor the wealth to support their own industries. production. the huge U. Comparative advantage governs international trade. According to our classical economics. industry has begun to decline. But in global competition. Rather. this new relationship becomes self-liquidating. economy more in line with the lower-standard-ofliving countries against which free trade has pitted us. What it actually illustrates is that if the two nations require their trade to be in balance. and then substitute more practical attitudes toward the role of trade in our economy Seven myths in particular dominate conventional thinking about trade.S.S. When trading nations require their trade to be in balance. Others argue that the way to bring U. Frantic cost cutting to accomplish what is impossible destroys the future capabilities of companies as well as the nation. industries without forcing a domestic decline in real wages and the standard of living. To justify free trade. diminish U. and bring the U. Rather than a self-sustaining. Much of the debate over trade today is conducted within a narrow range of thinking. Many other industries are also going through massive cuts in future-oriented expenditures. international trade is governed by comparative advantage. Unlike the historical demand-andsupply relationship between market and industry. companies can become competitive through cost cutting.S. A decline in the dollar is simply a way for the United States to become poorer It is a way for the American economy to accede to the inevitable results of competition from lower-wage and lower-standard-of-living nations by becoming itself a lower-wage. chopping investment. market. buying power. Again.September-October 1986 124 Harvard Business Review U. they can find ways to economize within their companies-always a useful measure at Underlying myths of free trade . a set of ideas dictated by classical economics. It depends on differences in the internal structures of prices in the trading countries and is not affected by differences in their absolute levels of costs and prices. trade deficit and the export of American industries and jobs indicate only the need for an adjustment in the exchange rate: a decline in the international value of the dollar would make everything all right again.

taken in the name of achieving competitiveness. this approaeh can delude an American business into thinking it has restored its competitiveness. factories. If the standard of living in a low-labor-cost economy is low. granting unlimited access to our market is like signing a blank check-which nobody . If begun on a small enough scale. market even more under universal free trade. In the United States. We would only suffer more broadly tbe destructive consequences of free trade. To shift production from the United States to low-wage foreign labor may cut costs hut does not necessarily raise efficiency. the price system works perversely. Tbis argument is based on a false assumption. however. since they generally have cheaper labor and yet increasingly use more of the advanced technologies of advanced nations. But the company that chooses to go this route will eventually find itself faced with deeper and deeper cuts. Economists often assert that the production of something more cheaply in one country than in anoth- 125 er is evidence that it is produced there more efficiently and therefore should be produced in the cheaper country. and giving up products become essentially importers of foreign goods.A popular argument designed to deal with the rising flood of foreign imports is the notion of the level playing field: since most of our foreign competitors do not play by the same trade rules as the United States. or with lax production regulations. such a position is good neither for us nor the LDCs. Some American companies have already reached the last steps-firing skilled people. Lower cost is linked witb efficiency only when the goods under examination are of equal quality and the producers are all operating under the same rules. In international trade.S. these countries must admit our goods to make things fair. or pressured into adopting our rules against their self-interest. our foreign competitors will actually exploit the U.Free trade C-^ WORLD TRADE PERIPHERY the start. This is because low-cost labor. These actions. including government and labor policies that reflect accepted social and environmental values. means a lower standard of living. Companies that shift production abroad through outsourcing. will only destroy the company's capabilities. The United States should give LDCs unlimited market access. closing U. cajoled. telephone equipmentperhaps in most manufacturing industries. this argument is used to support the conclusion that goods that can he made ahroad more cheaply-and presumably more efficientlyshould be made abroad. Such a shift has been prevalent in automobiles. how can anyone sensibly call that economy efficient? In shifting production to countries with low wage rates. Almost inevitably the process changes from cutting fat to cutting meat to cutting close to the hone. Our trade would not be brought into balance-certainly not at any acceptable standard of living-by other countries adopting free trade.one that the foreign source will understand and gradually exploit by capturing more and more of the product's value-added and eventually discarding the empty shell of the American business. scaling back investment. footwear. For two reasons. establishing joint ventures with foreign companies. it is an admission of defeat . apparel. Two things are wrong with this argument. computers. they will not be threatened. building new ones abroad. Then we will be playing by the same rules-our rules. The argument that the United States has a responsibility to help less developed countries by granting them free access to its market has a humanitarian ring. The second path is more direct but leads to the same outcome: to lower costs. It does not take much imagination to see what lies at the end of this road. free trade actually reduces economic efficiejicy-as does producing goods for the American market on the opposite side of the world in order to take advantage of cheap labor. with large govemment production subsidies. Low cost does not imply efficiency. In fact. since many other nations do not suffer from our delusions about free trade. American companies can tum to offshore sources and buy components or finished products from lower-cost foreign companies.S. First. All it takes to make free trade work is a level playingfield. by definition. First. abandoning research and development. Second. Low-cost goods are efficiently produced goods.

S. Harvard Business Review September-October 1986 A realistic trade policy Witb imports pushing them against the wall. When that happens.sbould give American executives pause before they leap over the fence.S.S. Despite its fashionable ring. American companies will be tbe natural target of frustration and disappointment.S. American companies in many industries bave seen only a narrow choice: leave the industry or move production overseas. are moving their production abroad or buying foreign production for resale. The experiment can only fail.S. Second.S. the argument falls of its own weight. which leaves out the prospect of a constructive U.S.126 should ever do. companies-restoring the self-reinforcing process of economic growtb in this country-American companies that have gone abroad will be on tbe outside looking in. and policies. trade policy begins to reconnect the powerful domestic market witb U. their basic economic underpinnings would remain unchanged. with its implied override of national economic objectives.S. trade policy finally comes. the operations of American companies in other countries are unlikely to receive favorable treatment or political support. Louisiana to a new factory in Singapore typifies one reaction to these inexorable pressures. Tbese days it is increasingly fasbionable for Americans to say tbat tbe separate national economies must inexorably evolve into a global economy. companies that have moved abroad will find themselves on the wrong side of the fence. for each of them the benefits could he so small as to produce no marked improvement in their standard of living. Tbe prospect of operating in sucb an environment-with but limited access to a rebabilitated U. tbe United States will put limitations on foreign imports to balance America's trade. Ratber than blithely assuming that a world economy is inevitable. interests. It is not true tbat all nations desire thoroughgoing international economic integration. we are guiding these nations into a blind alley. The decision of AT&T to give in to foreign competition and shift production of telephones from Sbreveport. Given this cboice. Put this way. market to shrink. No nation is willing to preside over its own economic ruin. For example. As a more reasonable U. At some point in the not-too-distant future. in a world in whicb nations generally will be bard-pressed to meet domestic demands. engaged with one anotber in mutually beneficial trade and constructive competition. From pressure in Congress to a new pragmatism about trade in tbe Reagan administration.S. is for American business leaders to support a change in trade policy now. In fact. Moreover. while less developed countries could cumulatively cause serious erosion in the U. managers choosing to move overseas should realize that there is no guarantee of success abroad. trade policy opening a third option-remaining competitive at home-most companies. standard of living. This is simply the latest version of tbe kind of wave-of-tbe-future rhetoric that economists and others have applied to many movements now dead and forgotten. economy to decline and the U. . The proposition is that the spread of free trade and international economic integration will proceed because all nations approve and desire it and because it will be successful. economy and a flourishing U. Under U. A far more humanitarian approacb would be for tbe United States to advise tbese nations to tie their economic programs into a pattern that would prove workable and sustainable over tbe long run. production base under existing trade policy. of course. The change to a global economy is inevitable and desirable. Moreover.S.S. tbis oneworld doctrine is dangerous. And tbe destructive effects of free trade are now so obvious tbat at some point the United States and other high-income nations will wake up before worldwide economic integration drags tbem down into worldwide poverty. they are being asked to cboose between two losing strategies: they can cease production now in the face of unfettered importation or tbey can move abroad and find themselves on the wrong side of the fence when the change in U. the American exodus to foreign production bases may bring about tbe very circumstances that will undermine that move. market. tbe signs are clear: America's willingness to play victim to the free-trade doctrine is unlikely to continue much longer. Japan-a model of realism and success in so many recent competitive undertakings-is bardly rushing to submerge itself in a one-world economic commune. It simply reinforces the folly of free trade. But wbile it may be hopeless for these companies to try to compete from tbeir U. Tbe correct course is for nations to get tbeir own economic affairs and their own international trade under control and to use tbe only functional structure tbat works-a world of effective nationai economies. before it is too late. The solution. Also. eitber because the United States belatedly wakes up to tbe ruinous effects of this approacb and limits imports or because the wage competition causes tbe U. market. in encouraging LDCs to base their economic advancement on exploitation of the U.S. preferring foreign production to corporate failure. trade policy. we should expect worldwide economic integration to stop before it spreads much further.

imports as in the principle of comparative advantage rather than by allowing low-wage foreign producers to generally undercut U. It would set limits on the proportions of U.S. The interest of the nation in balanced trade is in concert with the interest of American business in guaranteed access to the American market. abandoning the small-car market to imports. 4 In balancing its trade. quotas would begin the process of designing a system of mutually beneficial trade between us and our trading partners. just as limitations on immigration are. in some cases. production and moving their operations offshore. 3 To balance its trade and continue its economic growth. Over time these targets would be tied to a balanced pattem of trade.S." A revolution in ideas that replaces sloganeering with pragmatic analysis must underlie the revolution in accomplishments.S. trade with low-wage nations would virtually exclude imports from other highincome nations and would thus discriminate against those with high incomes. To hold the line.S. we would send foreign producers a clear signal of what to expect in the way of access to our market. the high-income. 6 Countries must manage their trade in ways that meet their particular needs and capabilities. reversing recent rapid growth." "Protectionism is bad. tariff rates high enough to balance U. at least halting their increase in market share and.Free trade A realistic trade policy would end the general underselling of American production by foreign production. 5 Import limitations supposed to be nondiscriminatory-such as tariffs-are actually very discriminatory. 2 Making trade among diverse nations constructive means balancing it and preventing destructive shifts of industries between nations. is being liquidated through joint ventures with Japanese companies. markets that could be taken by imports and ensure for U. footwear. The once mighty U. apparel.S. economy urgently needs immediate action to stop unfairly advantaged imports from undercutting U.S. halt the erosion of the American economy. The new policy would put U. or giving up on U. textiles. The goal is a comprehensive trade policy that protects and defends the interests and future of the United States-that protects the nation rather than any special interest. These accomplishments will be possible only if we move heyond the slogans that dominate the trade debate: "Free trade is good. located in the nation with the world's greatest market for automobiles. American companies are sinking. Government is the only agency that can assume the responsibility for managing a nation's trade budget in a way beneficial to the interests of the nation. 127 7 National govemments have a legitimate and necessary role in arranging constructive intemational trade. the targets would tell American producers how . The inadequate quotas on autos. steel. industry a market on which it could rebuild and resume its advance. In establishing the targets. Just as they need a fiscal budget to keep expenditures in line with incomes. nations need a trade budget to keep imports in line with exports. American business must play the decisive leadership role. administrative capabilities. exporters through their absolute cost advantage. causing destructive competition among nations. Two kinds of trade policies. National differences in circumstances. The imposition of quotas would be a step in the direction of import limitations to balance our trade. a nation with a high standard of living and an attractive market will find permanent limitations on imports necessary. the dimmer our economic future will be.S. we should immediately impose quotas on certain goods. and begin to move in the direction of balanced trade and some permanent measures that will ensure balanced and mutually advantageous trade among nations.S.S. Even more important. and other factors are too important to permit any uniform and general system for arranging intemational trade. trade The U. uniform U. For example. trade policy: 1 In a world of diverse nations.S. free trade works perversely. A number of principles should guide this effort at understanding and shaping a new and pragmatic U. therefore.S. exports on a strong foundation by tying them to U. These arrangements could bring about balanced international trade that would correspond to comparative advantage. high-cost nation will tie its exports to its imports through trade packages or through exports subsidized from the proceeds of import licenses. and machinery can serve as a point of departure. Balancing U. shifting the design and production of its cars abroad.S. producing American cars largely with foreign-made components. Month by month. The United States should quickly establish provisional targets for the maximum share of its market available to various foreign-made products. The longer we allow this process to go on unchallenged.S. automobile industry. failing. including wage competition that tends to reduce all nations to a lowest-common-denominator standard of living. need to be put into place: some first steps to hold the line. production. ideologies. and shifting its capital to secondary industries.

We need to escape from this belief and build a new system of international trade-one that rests on realism and mutual benefit for all nations. In either case. industries as footwear. A trade policy that tries to force free trade on the world is doomed to failure-and would ruin us if adopted. Creating and administering a trade policy that meets these goals is a demanding task-but so is running a corporation in today's world. September-October 1986 A time to rethink In touting free trade to other nations. n Produce balanced and mutually advantageous trade plus debt dealings with each nation. nation-group. By moving to such a policy we would be helping low-income nations develop sustainable economic programs and safeguarding the living standards of high-income nations. market.S. judgment. that of the company and that of the nation. We must treat the import limitation program as a set of serious business contracts between nations . simple slogans that promise easy success are unrealistic. and apparel.S. and changing economic environment is a hard-won achievement. We must repudiate the notion that the rest of the world can achieve economic growth by unbalanced sales to the U.not as a theater for acts of political symbolism. administrative effectiveness.128 Harvard Business Review much of the domestic market would be reserved for them so that they could begin gearing up for U.S. We owe it to all countries of the world to put to an end the unrealistic idea that more countries can emulate Japan and achieve economic advance through a parasitic relationship with the American market. Such a system must serve a number of goals. Its size and wealth give it great value to foreign producers and other nations. We should capture this value for the benefit of all Americans through two mechanisms: quid pro quo trade packages arranged with other nations and the sale at market price of a limited number of import licenses. A successful trade policy requires foresight. the United States has not only invited its own economic destruction but also misled other countries in their expectations from international trade. Intemational Trade Organization regarding the economic injury that foreign competition has inflicted on such U. the development of breakthrough technology. The permanent system of balanced trade should be based on the inherent value of the U. Some quotas should be based on existing legislation and on the findings of the U. The United States should enforce these import-limiting arrangements rigorously and promptly -not in the way that the govemment now handles these matters. the delusion will hurt many of them. It is time for America to reject this false god and accept the hlame for preaching an unrealistic doctrine. and toughness in enforcing rules and regulations. and the world. realism. We should strive to detect trade violations quickly and take immediate action. But we should reject the notion-on which ITO is based-that quotas are only a temporary remedy designed to give domestic industries time to shrink or become competitive. and the kinds of jobs required. Moreover. The delusion that free trade is the road to worldwide affluence has influenced many countries. producers by taking into account factors like the defense implications.S. textiles. The hope of the United States lies in recognizing and tackling this difficult task rather than in waiting for Providence or free trade to bring us success on a platter. The basis of a realistic U. interests and reserves a defined share of the home market for U. honesty. A permanent system limiting imports to the U. the kinds of jobs produced.S.S. Apart from transition problems. It must: market.S. n Preserve the United States as a highincome nation with a great market for advanced goods. We should use part or all of the revenue generated by these sales to support particular U. ^ . trade policy is a permanent system of limitations on imports to the American market. production and at the same time spell out the clear dangers of moving more production overseas.S. At both organizational levels.S. adapting successfully to a complex. D Produce an industrial composition of trade that serves U. punishment must provide real remedies rather than the long-delayed hand slaps delivered now. Our new trade policy should make it clear that we want permanent limitations on imports to the American market. industries whose products we want to export to further national interests. market and maintaining balanced trade should eventually replace these temporary measures. coupled with the promotion of desired exports within the framework of balanced and mutually advantageous trade with other nations.S. knowledge. Mutually beneficial and balanced international trade is the only trade policy that makes sense. just as the operations of large companies do. it would do no violence to any nation's valid claims. uncertain.

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