Despite Adam Smith’s definitive explanation of how free trade could benefit both parties engaging in trade, pretty much every society is skeptical of free trade and that other country stealing our jobs. So, today, we have the specter of some of the richest nations in the world appalled at the thought of having to compete with some of the poorest nations, and all too happy to condemn the developing world to poverty by closing off markets.
Surprisingly there isn’t actually a lot of research looking at how free trade affects industrialized countries, but Virginia Postrel published an article in the New York Times in January that explored just this topic.
She reported on an academic study of the effects of the Canada-U.S. Free Trade Agreement. The study, by Daniel Trefler of the Rotman School of Management at the University of Toronto.
Trefler’s study focused on the effects that liberalizing tariffs between the two countries had. Postrel writes,
Before the agreement went into effect in 1989, more than one in four Canadian industries were, in fact, protected by tariffs of more than 10 percent. Those industries included not only businesses known for their protectionism, notably apparel makers, but manufacturers of a wide range of products, from beer and pretzels to coffins, plastic pipes and paper bags.
Before the agreement, imports from the United States faced an average tariff of 8.1 percent and an effective tariff of 16 percent. The effective rate included import taxes on the final product and tariffs plaid on raw materials. Someone importing a chair could face a direct tariff on furniture, for example, but could also pay indirect tariffs on wood and upholstery fabric.
At the very beginning of the free trade agreement, those industries that were the most heavily protected took big hits as imports from the United States became even cheaper. According to Trefler, such industries, saw employment declines of as much as 12 percent, and the free trade agreement as a whole reduced employment by 5 percent in industries that had previously been protected by tariffs.
But, over the long run, the Canadian economy regained those jobs and has one of the healthier industrial bases in the developed world. According to Trefler,
Within 10 years, the lost employment was made up by employment gains in other parts of manufacturing. . . The average effect of the U.S. tariff cuts on Canadian employment was thus a wash: the employment losses by less-productive firms offset the employment gains by more productive firms.
And rather than force Canadian wages into a downward spiral, as had been predicted by opponents of the free trade agreement, Canadian wages increased by 3 percent over the eight years studied. A small increase to be sure, but not the predicted decline.
So what did Canadians get out of the free trade agreement if employment was a net wash and wages increased just slightly? It got a big productivity boost. Postrel writes,
The big story is that lowering tariffs set off a productivity boom.
Formerly sheltered Canadian companies began to compete with and compare themselves with more-efficient American businesses. Some went under, but others significantly improved operations.
The productivity gains were huge. In the formerly sheltered industries most affected by the tariff cuts, labor productivity jumped 15 percent, at least half from closing inefficient plants. “This translates into an enormous compound annual growth rate of 1.9 percent,” he [Trefler] wrote.
But closing plants is not the whole story, or even half of it. Among export-oriented industries, which expanded after the agreement, data from individual plants show an increase in labor productivity of 14 percent. Manufacturing productivity as a whole jumped 6 percent.
Free trade — its good for you. Even you folks in the industrial world. So loosen up those protectionist tariffs and quotas already, and give the developing world a fair chance.
What happened when two countries liberalized trade? Pain, then gain. Virginia Postrel, The New York Times, January 27, 2005.