This is the fourth in a series of six posts about the trouble in America today and policy solutions going forward.  The first post is about income inequality, the second introduces the basis for my policy recommendations, and the third presents economic policies.  In this post, I will address policies related to international trade.

I know less about the specifics of free trade agreements, and, admittedly, they are one of the most contentious economic policies that exist.  I find myself on the side in favor of free trade agreements, and believe that they are fundamentally good for America. A lot of the proposals I have made in previous posts are ending inherent subsidies – whether tax breaks, refunds, or direct payments from the government – that do not benefit the economy as a whole. These solutions are generally associated with left-leaning politics. Free trade agreements, in contrast, are more often advocated by conservative politicians and liberal economists (yes – political conservatives are economic liberals).

Going back to how economies work, economic policy is dictated at the level of of the entity that is being governed. In my hometown, the board of selectmen granted the first liquor license to a restaurant, hoping to entice more restaurants to the town, which would generate higher taxes, which could then be spent on schools, roads, and other projects. People opposed it because they saw it as a slippery slope that threatened to upset the utter boringness of the place. They debated, and the other side won.

The same thing happens at a country level, only, instead of 15,000 people in a suburb outside of Boston, 300 million people have skin in the game. And when you open up borders to competition by establishing free trade agreements, like NAFTA (North America Free Trade Agreement) between Mexico, Canada and the US, or the TPP (Trans-Pacific Partnership) with the US and much of Southeast Asia, you not only strengthen relations with the those countries, reducing the possibility of conflict in the future, but also generate a tremendous amount of wealth by leveraging the competitive advantages of each country.

In free-trade agreements, countries agree to reduce or eliminate tariffs on one another’s goods. So let’s say that China and the U.S. both manufacture laptop computers. Because labor is so much cheaper, China is able to build a computer for $200, while it costs $300 to build one in the U.S. Now, if there were no tariffs, everyone would buy computers from China, and all of the U.S. manufacturers would go out of business. But U.S. politicians in districts where U.S. computer manufacturers have their factories would stand to lose if those companies went under. So they pass tariffs, which are effectively taxes on imported goods that are designed to make domestically-produced goods more competitive.

Here is how the International Trade Administration – an within the U.S. Department of Commerce – describes the impact of free-trade agreements:

Free Trade Agreements (FTAs) have proved to be one of the best ways to open up foreign markets to U.S. exporters. Trade Agreements reduce barriers to U.S. exports, and protect U.S. interests and enhance the rule of law in the FTA partner country. The reduction of trade barriers and the creation of a more stable and transparent trading and investment environment make it easier and cheaper for U.S. companies to export their products and services to trading partner markets. In 2012, 46 percent of U.S. goods exports went to FTA partner countries. U.S. merchandise exports to the 20 FTA partners with agreements in force totaled $718 billion, up 6 percent from 2011. The United States also enjoyed a trade surplus in manufactured goods with our FTA partners totaling $59.7 billion in 2012, a 30 percent increase from the surplus in 2011.

Tariffs are harmful for several reasons. First, they discourage innovation by stifling competition. When companies know that they can remain competitive through government intervention, rather than from greater efficiency, innovation, or marketing – they have little incentive to change. The same is true for monopolies. When was the last time you had a good customer service experience with Comcast, Verizon, or United Airlines (on which I am actually writing this post as I fly from San Francisco to Boston)?

Second, and more relevant to the present discussion, tariffs drive up costs for everyone else. If a computer costs $200 to build, consumers should pay $220 to buy one (or some other margin, which is irrelevant). Because of tariffs, they pay $320 instead. Instead of saving $100, which could be spent on other things, consumers pay more to inefficient manufacturers in order to preserve jobs.  The graph below explains how tariffs increase the price to consumers, creating an aggregate societal loss.

Passing FTAs is difficult, because, in the near term, people stand to lose their jobs. But, if you were to reduce tariffs in concert with the tax proposals listed above, the additional revenue generated not only from cost reductions, but also increased exports to other countries in the FTA, would allow the U.S. to invest in job training and other social welfare programs, like a higher minimum wage and a greater earned income tax credit (which I will explain in subsequent sections). As a result, you could enrich the broader population without completely pulling the rug out from under the workers whose jobs would be outsourced.

In my next post, I’ll talk about immigration reform.

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