A New Ideal for Free Trade
Updated: Apr 24, 2020
Free trade may be one of the greatest international economic developments ever to take place. It has lifted billions out of poverty, opened up countless capital markets, and made the world a more prosperous place. In aggregate terms, countries who engage in free trade are better off, especially at the consumer level, due to cheaper, more readily available consumer goods, enthusiastic capital investment, and greater economic freedom.
Yet, defining free trade as low barrier, low subsidy, exchange economics leaves out an important component that leads to simplistic and short-sighted analysis by both its supporters and critics. This missing component is the idea of market integrity. Market integrity in the context of trade is the understanding that market participants are engaging in economic competition independent of substantial government intervention or nefarious activity. This means reciprocity in establishing low trade barriers, providing subsidies, having an independent currency, and safeguarding intellectual property. It also means ensuring that worker compensation and business and environmental regulations are relatively comparative and that major firms are not acting maliciously towards their competitors. Perhaps the greatest factor in maintaining market integrity is the evolution towards a free-market economy. When government interferes in the marketplace, incentive structures become distorted and that not only crowds out competing firms but can lead to the creation of firms that in healthy market conditions, would not exist. In conjunction with government policy, these artificial firms can have a devastating impact on the overall economy and undermine the integrity of the market.
For example, mortgage giants Fannie Mae and Freddie Mac in the lead up to the 2008 financial crisis were major players in the residential mortgage market. Since the Clinton administration, political pressure had forced significant internal policy changes at these massive government-sponsored enterprises (GSEs); firms held by private shareholders and backed by the federal government whose mission is to extend credit to “underserved” sectors of the market (low-income groups mostly).
Consequently, federal housing policy reflected a desire to increase mortgage lending to low income, poor credit borrowers who under normal free-market conditions, would be deemed too risky by a bank to generate a home mortgage loan for. These aggressive housing policies, which strived to increase the homeownership rate (it had remained constant at around 64% from 1970-1995), created a dangerous incentive structure that enabled the rise of companies like CountryWide Financial and Ameriquest Mortgage. These firms specialized in creating subprime loans for unqualified borrowers which were then promptly sold to either Fannie Mae or Freddie Mac. When the financial meltdown began, 76% of subprime mortgages were on the books of the federal government through entities such as Fannie Mae, Freddie Mac, and the Federal Housing Authority (FHA). From major investment banks to middle-class families, the entire economy felt the wrath of the “make your own mortgage” frenzy of the late 1990s and early 2000s.
However, companies like CountryWide would never have been able to do the damage they did if the market had a sound incentive structure unaffected by intrusive government policy. The housing sector prior to the Clinton administration was not a liberated market, but the level of risk associated with Fannie Mae and Freddie Mac was not nearly as high. In a larger trade context, market integrity can only be ensured when the government does not have a heavy hand in the marketplace.
Another component of free trade is obviously free-market economics. Free-market economies require minimal subsidization, regulation, and taxation and markets participants decide, through economic interaction, what the rules are. Sound market fundamentals in major sectors of the economy are vital for establishing market integrity on an aggregate scale. Free trade is meant to bring together economies that have sound market discipline and comparable “laissez-faire” business environments. The best way to do this to negotiate and update free trade deals like NAFTA (now the USMCA) which outline comparative (yet reasonably achievable) and competitive market conditions. This can be tricky with countries that do not have the labor laws, environmental standards, or property rights protections like the United States. Vietnam, for example, has a monthly minimum wage of $304.17 and 128 out of 180 economic freedom ranking from the Heritage Foundation. The latter number, in particular, is not compatible with Western notions of market capitalism which emphasize, above all else, private property rights. In order to have a free trade relationship as understood by market integrity, the United States needs to leverage Vietnam to adopt liberal economic reforms by bringing them to the table for a trade deal enforceable by snap-back tariffs. The United States, to meet Vietnam halfway, should reduce government involvement in the economy by lowering taxes, cutting regulations and removing subsidies from select industries (energy, agriculture, etc.) in order to compete with their cheap labor and loose environmental regulation.
However, in the case of a country like China, a free trade relationship is not possible. Their companies steal technology (including from US defense contractors), violate intellectual property rights, and engage in dangerous corporate espionage with the full support of the communist government in Beijing. There is a strong case to be made that since China is so jingoistic in its quest for world hegemony, evident by its military expansion into the South China Sea and the $225-$600 billion of intellectual property stolen, the United States should close or heavily tariff their markets in order to protect national security interests and the integrity of Western firms. Prudence in choosing trading partners, as in the case of Vietnam or India, will lead to a better free trade system.
The importance of market integrity within a free trade system cannot be overstated. It allows consumers to have access to cheaper goods and firms to compete on a global scale. Discerning that trade is more than just reciprocally low barriers, low subsidies and open markets are crucial if a sustainable, ethical trade system is to exist. It is critical to have a system based on sound, comparable market fundamentals that will elevate economic competition and offer market participants the best chance to create win-win relationships around the world.