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Why Free Trade Economics Isnt Working

The late Jane Jacobs is the finest micro economist who ever lived. Of course, in achieving this distinction, she had the very great advantage of not being an economist. She was, in fact, thought of as an urban planner. By the time of her death, in 2006, she was considered to be among the foremost practitioners of this dark art. Yet again, her status within the urban planning profession was achieved in spite of, or, perhaps, because of, her never having attended a college or university.

Jacobs pursued a novel approach to the study and analysis of cities, rather than rely upon certified knowledge, she paid attention to what was going on, thought about what she observed and tried to draw from this some practical conclusions. Such heresy was frowned upon by the planning profession and mightily resisted.

Possessing no certified knowledge, her task of making the urban planning profession, and the grandees thereof, see sense was made all the more difficult. Even so, she did not shrink from the effort. She even took on the all-powerful Robert Moses at the height of his megalomania and, eventually, helped to remove him from any positions of power in New York City.

She wrote many, many books and articles on the subject of cities, what they are, how to gauge their health and what to do to make them better. Because of her, most major, urban projects, at least by the 1990s, followed some or all of her design precepts; high density, mixed use, short blocks, pedestrian friendly, etc. The fact that there is any livability left in any North American city owes much to this great lady. However, that is not the focus of this essay.

IMPORT REPLACEMENT

In her book, Cities and the Wealth of Nations,, Jacobs theorized that the economy of any given city grows, primarily, through import replacement. She postulates that only through a deliberate,

sustained policy of replacing imports purchased by residents of a given city with goods or services manufactured or created in that city can real wealth be expanded.

She illustrates her theory with an abbreviated economic history of Japan, both before and after WW II. She states that an unrelenting policy of modernization beginning with the Mejii Restoration, coupled with an insistence on import replacement with goods manufactured in Japan, resulted in the rapid metamorphosis of Japan from a medieval, feudal society into a modern, industrial nation state. Going further, she states that the process was repeated after WW II and the attendant, total destruction of the nations industrial and public infrastructure that occurred during that war. Japan rebuilt and improved its domestic economy by, again, taking all it could from the outside world in the form of technical transfer of science and engineering and applying that knowledge to the manufacture of goods designed to replace imports from outside the nation.

Jacobs observations regarding import replacement and the growth and health of urban economies are a by-product of her belief that cities are the fundamental economic unit of human society. She postulates a number of interesting observations and theories related to the defense of that position and her argument is strong, though, to me, not entirely compelling. (As an aside, among her arguments is the belief that cities did not emerge from the agricultural revolution as is thought by most historians. Contrary to the received wisdom of historians, Jacobs believed wealth follows knowledge and creativity. She believed the invention of agriculture and the domestication of animals occurred because cities already existed making labor differentiation possible and creative invention possible. While this is far from accepted doctrine, archeological evidence relative to the rise of agriculture and domestication of animals in Peru seems to support her construct better than the more widely accepted one.)

She had much to say about the dependence of rural hinterlands upon the city they surround and, in some cases, those that are far away. She had much to say about the need for cities to maintain their own currency, independent of any national currency, and many other theories. However,

none of these is essential to this essay. The most important observation she made, so far as the understanding of microeconomics is concerned, is the need for a city, regardless of its relative state of development, to replace imports if the wealth of the city in question is to grow.

Import replacement is not confined to item- for- item replacement of some particular good or service. Jacobs makes clear that her understanding of economic reality includes in the category of import replacement the creation of new goods and services that make old, imported goods and services obsolete. Therefore, the primacy of import replacement is as true for a technically sophisticated, developed society as it is for a less developed society. No matter what stage of technical and economic sophistication, import replacement is the key to the expansion of wealth within any society.

Jacobs limits her analysis to the effect of import replacement on cities. However, the mechanism of import replacement is so important to the expansion of wealth, it applies directly to any coherent group of people. Whether such a group of people abide within a single city or are spread out over many geographic areas, import replacement of goods and services coming from outside the group with items created within the group is the surest and fastest path to wealth expansion.

While Jacobs never made a wealth expansion claim for any human organizations other than cities, the principles she postulates function similarly for any coherent group of people. First, a vigorous policy of import replacement forces economic activity to take place within the group. Second, such a policy, by definition, requires the expansion of knowledge and understanding by individuals within the group of such techniques and procedures as are required to manufacture or otherwise create the replacement goods and services. Third, within the group, independent organizations/enterprises must be formed to manufacture or otherwise create the replacement items. These independent organizations foster a leadership class largely independent of the established leadership of the group as a whole. This new, independent leadership class is, itself, a valuable form of human infrastructure. Fourth, the economic imperative for organizations to

grow or shrink will force many of the new replacement enterprises to become so efficient they can begin to export the goods and services initially created for replacement purposes only. This export business represents a significant wealth expansion that is retained within the group.

Historically, the growth model Jacobs proffers for cities has been shown to work for any number of historically persecuted minorities. By way of examples, whether such a policy pertains to the numerous Jewish Ghettos extant throughout medieval Europe and the attendant rise of the international banking system or the rapid expansion of the black domestic economy in the United States that occurred between the end of Reconstruction and the advent of judicial decisions ending institutionalized segregation, the discrimination such groups experienced from the greater society to which they belonged, though evil, acted as a de facto tariff protecting enterprises creating replacement goods and services from competition. In turn, this protection allowed those enterprises that were operated efficiently enough, time to grow, stabilize and, in some cases, begin to export goods and service to the wider world.

As the reader might imagine, modern, free trade economists do not take Jacobs very seriously. The concept of any artificial protection from competition is considered, by free traders, an economic inefficiency. Such inefficiencies are thought to be detrimental to both the internal and external economies concerned with a given transaction. The free traders believe that goods and services should be produced where they can be most efficiently produced. This premium on efficiency of production is the central theory of the free trade school of thought. It is the primary theory that has been elevated to a belief, an article of faith.

In so far as the free traders limit the debate to the question, How does a given society benefit if all it gets from inefficient production (as measured by higher monetary costs) of some good or service is the replacement of an imported version of that good or service?, the inefficiency of import replacement seems reasonable. The free trader answer to this question is, there is no benefit. Indeed, the free trader will assert such a policy of import replacement, in so far as the

policy includes artificial protections against outside competition, is a detriment to the society imposing it.

However, the free trade answer has merit only if the definition of costs is limited to current monetary costs. If the definition of costs includes non-monetary costs, including opportunity costs of both a monetary and non-monetary type (all of which any reasonable definition of costs must include), the free trader argument is faulty on two grounds. First, it presupposes that efficient production is, if not entirely geographically static, permanently in the residence of one of more current producers of the good or service. Second, the exclusive focus on the monetary or material cost of the good or service misses the most important value of an import replacement policy. Import replacement is primarily valuable to a given society because it expands the knowledge base of that society and the human infrastructure of that society. Creation of wealth within a society is far more dependent upon the knowledge and creativity of the human infrastructure of the society than on material goods. Knowledge, creativity and leadership begat wealth, not the other way around.

There are many means to expand the knowledge, creativity and leadership within a society. However, expanding all these traits is a natural by-product of a policy of import replacement. When the costs of providing these traits be other means is calculated, these may prove far more costly as well as far less efficient than an import replacement policy.

US POLICY

The official policy of the United States, at least since the administration of the first Roosevelt, has, off and on, been to pursue a vigorous policy of export replacement. The US avoided the worst effects of such a sustained and short- sighted policy by aggressively funding and expanding public secondary and public higher public education.

Throughout the twentieth century, education policy was a function of state and local government. Most areas of the nation followed similar policies toward public education, offering consistent support. Aggressive support of public secondary and higher education was particularly present in the far west and Midwest. The University of California and he California State University systems were, along with many outstanding public universities in the Midwest, some of the leading universities in the world, and did so during most of the last century.

To feed these new leading universities students prepared for the rigor of an education equal to any available anywhere in the world, the states, particularly California, also invested heavily in public primary and secondary education. Many Midwestern states did the same.

As long as tecnicaltechnical knowledge that would otherwise be achieved through a policy of import replacement was effectively replaced with the products of the far western and midwesternMidwestern public education systems, the United States was able to maintain a world lead in scientific, engineering and technical education. This educational lead allowed the country to maintain an export replacement policy without suffering the immediate negative impacts of such a policy that is always an inevitable attendant thereto. The presence of these negative impacts were always there but were masked by the continuous explosion of growth in the new and/or improved industrial production. This industrial expansion was a direct result of the educational policies of California and a few other western and Midwestern states.

Beginning in the late 1970s two unfortunate policy shifts became permanent in the United States and the various states. Again, this shift was particularly true in California. Heretofore, educational policy in the states had given the US a means to mask the negative impacts of the sporadic export replacement policy of the federal government. The first policy shift, beginning under President Jimmy Carter and continuing under every subsequent President, was a radical export replacement trade policy that became the central tenant of the nations foreign policy. The free moment of goods, services and capital became the consistent goal of all the nations diplomatic efforts. The addition of the free movement of capital was, as a central, controlling

tentanttenet, new to the foreign policy precepts of this nation. Prior to Jimmy Carter, free traders had pursued a policy that allowed the reduction of barriers to the movement of goods and services between nations. Under Carter, and every subsequent President, the concept of the free movement of capital between nations took hold and the acceleration of export replacement was dramatic.

The second permanent policy shift was the low tax movement that began in California, championed by then gubernatorial candidate Ronald Reagan. The movement found fertile ground in California and spread rapidly throughout the far west and Midwest. The advent of this low tax movement coincided with reductions in federal support to public primary, secondary and higher education. As the revenues, in real dollar terms, began to dry up in the various states imposing dramatic tax cuts, appropriations to the public schools and universities became static and then, in real dollar terms, began to be reduced.

The inevitable result of this double policy whammy; the permanence and expansion of the free trade policy of export replacement, combined with the collapse of the masking effect provided by excellent public education systems in the west and Midwest;, was an acceleration of all the negative impacts of an export replacement foreign and trade policy.

Making matters much worse, the negative effects of an export replacement policy are binging exacerbated by the reckless and irresponsible deficit spending under the current Bush administration. The huge, historically unprecedented debts being incurred by the nation, various state and local governments as well as individuals and corporations would not have been possible absent the successful expansion of export replacement policy to include the free flow of capital.

The current debt obligations of the nation and its citizens and political subdivisions are all but unmanageable. The future obligations the nation has accepted due to its aggressive, militaristic foreign policy and the future, social service entitlement costs will require a combination of a further, rapid increase in the national debt and dramatic increases in taxes. Even so, these will not

be enough to sustain the costs of projected ongoing operations and debt service. The result of the shortfall in revenues will be a diminution in both domestic government services and military readiness.

The United States now faces five formidable trade adversaries. The use of the phrase trade adversary is, in itself, likely to attract objections. Indeed, a better term might be trade rivals as it is not suitable to think of a trading partner as strictly adversarial when one is in partnership one minute, and in competition the next.

These primary trade rivals are: Europe, China, India, Russia and the nations of the Pacific Rim. Though the United States has been in a global rivalry with the former Soviet Union, now Russia, since the end of the Second World War and in intense trade competition with Japan and other nations of the Pacific Rim for at least four decades, the expansion of this rivalry to include China and India is a recent occurrence. For a long time Russia (except for weapons, other war machines and domestic aircraft), China (except for weapons) and India were not significant trade rivals. These countries were held back by socialist/communist command economic systems that prevented any of the three from being fully competitive on the world stage. Internal economic policy shifts within these three nations, coinciding with, but were not necessarily related to, the shift in US foreign policy in support of the free movement of capital, resulted in establishment of modified demand economies in each. This vast new economic freedom in combination with the free flow of capital from Western states resulted in an economic expansion within these trading rivals that is historically unprecedented.

The individual nations of the European Union (EU) have been trade rivals, off and on, to this nation from its earliest existence. The movement toward a unified economy inside the EU began in earnest after the Second World War. With the advetadvent of effective monetary and fiscal controls in Brussels and the promulgation of a unified currency, Europe has emerged as one of the worlds biggest markets and is an international trading powerhouse.

To take advantage of the benefits of lower production unit costs made possible by a single European market, the EU continues to practice policies of import replacement in many industries. These policies, combined with fiscal and monetary policy designed to strengthen and fortify the Euro, have made the EU a powerful trade rival to US industries that were unchallenged as recently as one or two decades ago.

Of the major trading rivals identified, four, China, India, Russia and Europe utilize a modified import replacement strategy. Alone, the United States uses an export replacement strategy as the central tenant tenet of its foreign and trade policy. While the other four incorporate some of the philosophical features of a free trade/export replacement policy in their foreign and trade policy, each of these rivals restricts and protects large portions of their domestic industry from the full impact of international competition.

Simultaneously with the dramatic rise in the power of the United States trade rivals, the US policy of dependence upon foreign sources of oil for energy created powerful centers of capital that are not aligned with any of the major trading regions/nations. The various governments comprising the Organization of Petroleum Exporting Countries (OPEC) have stock piled enormous reservoirs of capital in the form of money, mostly US dollars, and other form of highly fungible assets. Many of the international financial centers created by the US policy of energy dependence are concentrated in the Arab states of the Persian Gulf. These states, together, represent something new in international relations. These states, for the most part, have adopted a different economic model, based not on import replacement or export replacement but migrating toward the de facto role as the worlds banker and logistic service provider.

Already, the central role these banker/logistic nations play in world trade and world affairs is significant. If the model they have adopted is fully achieved, they will be in a unique position to exercise influence on all aspects of international relations.

REALITY BITES

The United States, as a result of its continuing policies of 1) export replacement, 2) dependence upon foreign oil for energy, 3) free flow of capital, 4) an aggressive, militaristic foreign policy, and 5) unaccountable future obligations arising from domestic social service entitlement programs, finds itself in a difficult situation. There are very few options, none of them particularly palatable, to face and overcome these difficulties.

There are those who believe the United States can simply grow its way out of this sad situation. While this option is a distinct possibility it requires the highest negative current costs. In particular, it will require the government of the US to make a fundamental choice between older Americans and younger Americans. The vast majority of current and future entitlement costs are incurred from social services to older Americans In order to use public education as an effective substitute for the knowledge, technical transfer and creativity that accrues naturally to a society using an effective policy of import replacement, dramatic funding increases are required at every level of public education. This will require most of the funds now being used to provide social services to older Americans be redeployed to fund education of younger Americans. Whether this redeployment is direct or indirect, allocating Social Security Trust Funds to pay down the national debt being an indirect example, the amount of funding for social services for older Americans will have to go down, in real dollar terms, if educational funding for younger Americans is ever going to be sufficient.

This stark policy choice, though a virtual political impossibility, may become unavoidable. The nation now has few options to significantly modify policy and/or spending. As politically impossible as a major funding shift from older Americans to younger Americans may be, other changes to funding and policy may prove disastrous. The relentless pursuit of foolish, detrimental policy initiatives by the current and previous administrations may prove impossible to unwind in a timely fashion. The very permanence of many of these policies have has resulted in their being ststus as a critical to element of the fragile system of international trade and order.

While the nation can immediately reduce the aggressive nature of its military and foreign policy, significant saving from reductions in military funding is impossible. The international climate created by the imposition of a pax Americana since WW II, greatly aggravated by the short sighted and foolish, aggressive militarism of the current Bush administration, will not permit rapid, unilateral withdrawal from anywhere in the world. As the United States currently spends more on its defense agencies and military than the rest of the developed and developing world combined, there is nothing to replace the US military. The world cannot afford for a reduction in service capacity or funding for the US military. Indeed, if anything, world reaction, both positive and negative reaction, to the current policies of the United States government make an expansion of world military service levels almost mandatory. Unfortunately, this is an expansion the United States cannot afford or sustain.

RADICAL IDEA ONE

An option to these reductions in service and quality brought on by the combination of reckless spending by the current government and the sustained export replacement policy of the federal government is to treat the military as a service to the rest of the world and charge for it.

As things stand, the vast majority of those receiving the benefits of the global defense system maintained by the United States do not incur any of the associated costs pertaining to the defense system. The worlds trading nations are completely dependent upon the United States Navy for the safety and security of the sea lanes. The worlds trading nations, particularly those dependent upon the extraction and sale of bulk natural resources, are deeply dependent upon the United States air and ground forces to keep rouge nations from imposing logistic or financial restrictions on their access to world markets. Industrialized nations marketing products throughout the world are, likewise, dependent upon the United States military and the defense system it enforces to maintain their access to markets.

It is not unreasonable that nations directly benefiting from the global defense system maintained by this military presence help pay for it. Such a cost sharing system would have the effect of reducing costs and eliminating a portion of the reason for future budget deficits. However, it would not be long before those helping to pay for the system would begin to demand a formal mechanism whereby they can exercise some control of how the system is deployed and operated.

While there are very good arguments to be made for migrating from one or more super powers bearing the military responsibility for the maintenance of world order to control by some international body, it is unlikely to be palatable to the nations citizenry. However, current monetary, trade and fiscal policies, if they are maintained, will precipitate a financial crisis that makes this option, or a dramatic contraction of military operations, unavoidable.

There may be other ways than exporting police and military services to the world for the nation to sell and grow its way out of the unfortunate mess we are in. However, short of a dramatic change in the structure of the nations economy, there does not appear to be any likely candidate(s).

Only a major change in the trade policies that have operated by consensus for the past forty odd years offers a path out of the current mess without having major impacts on our civil liberties and our traditional relationships with the rest of the world. These modifications will arise from the unique demands professional military service imposes upon individuals who, and nations that, enforce an imperial code.

RADICAL IDEA TWO

To avoid the United States having to act as the de facto policeman for the world and becomes the enforcer of a world imperial system, the major trading rivals could simply divide the world in to spheres of hegemony. This would have the advantage of dramatically reducing the financial

burden on the United States for enforcing the order of world commerce. However, it would change the five rivals from trading rivals into military rivals and would, therefore, create a very unstable world governance system.

However, it is a possibility and there may be international structures that could be created to alleviate the problems of instability.

RADICAL IDEA THREE

It might be a faster and more effective way to grow our way out if the US immediately adopted a strict import replacement trade policy and jettison the old export replacement policy. However, while, it makes perfect sense to migrate toward an import replacement policy at least as restrictive as our major trading rivals, anything beyond that could result in the immediate collapse of the international trading system with unforeseeable consequences. For the long term, our best approach is to institute a dramatic shift in domestic funding away from social services for older Americans and toward public education for younger Americans. This, if done, should be done in conjunction with a policy of migrating from the over open free trade now in force to a European import replacement model.

RADICAL IDEA FOUR

It should be possible to focus a significant portion of the educational funding resulting from that domestic funding shift to research in various energy technologies. Growing domestic, renewable sources of energy will be required if the United States is to become energy independent. Energy independence is the most important import replacement policy the nation should pursue. There is no reason why the nation cannot achieve energy independence within five years if it is made a central tenant tenet of US domestic and foreign policy.

Failure to implement the funding shift from social services for older Americans to education for younger Americans and energy independence within a five year period will result in dramatic, and perhaps permanent, reductions, in real dollar terms, of funding for both domestic and military services.