Free Trade Is a Magical Thing, but It Won't Save Europe

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A U.S.-E.U. free trade deal is a good idea -- but one that wouldn't be that big a deal

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(Reuters)

There's only one thing economists love more than free trade. That's telling everyone else why they should love free trade too.


This rare exuberance from the practitioners of the dismal science is understandable. Free trade is the closet thing economics has to magic. The trick, and it's quite a trick, is you don't even need to be better at making something than somebody else for you both to be better off from you specializing in it (and trading it). As long as you both make different goods with different efficiencies, you can both gain from trade by focusing on your more efficient good. And these gains can be big -- similar to inventing new, labor-saving technology -- since specialization lets you produce more in less time.

But -- you knew there was a "but", right? -- there are plenty of caveats. Every magic trick has some. In the case of free trade, the logic falls apart when the economy isn't at full employment, and even when it is, the gains from trade won't be equally shared. In other words, everybody will pay less for goods, but some will earn less, or lose their jobs entirely. As Harvard economist Dani Rodrik points out, economists generally don't like to talk about these caveats with non-economists, which is why he jokes you'll get different answers from economists about it depending on whether you tell them you're a journalist or an economics grad student.

That's a rather long-winded way of saying I expected to hear how the free trade deal President Obama wants with Europe will be a big, economy-boosting deal when I called up University of Michigan economics profess Alan Deardorff. That's not what I heard.

Trade is already mostly free between the U.S. and Europe -- as Deardorff said, "it's the same stuff going across the Atlantic with different brand names" -- with tariffs averaging just 3 to 4 percent. Now, as Deardorff explained to me, the efficiency losses from trade barriers rise with the square of the tariff -- so once tariffs get low, the harm they're doing gets lower. In other words, Deardorff couldn't "really see it would be a big deal" to move from 3 to, say, 1 percent tariffs with Europe. But even that probably overstates how much would get negotiated. Thorny issues like anti-dumping rules, regulations, and agriculture subsidies probably wouldn't be part of any deal, especially the latter since that would allow other countries to demand equal treatment. Indeed, the German-based Ifo Institute estimates a smaller deal focusing on reducing custom duties would only increase GDP per capita by about 0.1 to 0.2 percent.

But that doesn't mean a free trade deal wouldn't be worthwhile. It would be. If nothing else, it would set an example for the rest of the world -- and make other countries want to expand their boundaries of free trade, lest they be excluded. Those are boundaries the U.S. can't expand that much more on its own. As you can see in the chart below, via Paul Krugman, our tariffs are low enough that there's almost nothing to be gained from lowering them further.

DeclineProtectionism.png

In other words, free trade is a good idea whose time has already come. That's why a free trade deal with Europe is one even an economist can't get too excited about. It's a magic trick we've already performed.
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Presented by

Matthew O'Brien

Matthew O'Brien is a former senior associate editor at The Atlantic.

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