Understand you gave a talk at Harvard last week in which you called for a "new nationalism that adheres as much to American values as it does to the dictates of the marketplace". I enclose some thoughts in support of your position which you might find it useful to include in future talks. These ideas are based on my doctoral dissertation presented at Harvard thirty years ago, less successfully since as a trade specialist in a series of State Department papers (which never saw the light of day), and more currently in several exchanges of letters with the Economist Magazine , which considers my position neo-protectionist. It isn't. Read on.
As long ago as the December 10, 1990, Business Week carried an article by the respected American Economist Robert Kuttner citing a 1956 Lipsey/Lancaster paper The General Theory of the Second Best , of which I was regrettably unaware when about the same time I wrote my doctoral dissertation on The Theory of Second Best , under Professor Richard Caves at Harvard. As one reads about the failure of the US appeal to the WTO re the Kodak case, and reflects on the recent (and still looming) commercial bank failures in the Far East, the seven year old recession in Switzerland and almost as long one in Germany which threaten great economic disaster, there is indeed a rising protectionist sentiment which we should all be concerned to see channeled productively lest we fall into the beggar my neighbor trap which set off the Great Depression of the 1930s. But however true this may be, it does not automatically mean we must fecklessly chase a Free Trade rainbow while the world goes down in another round of economic flames, whatever free trade purists may think.
Lipsey and Lancaster cogently (and I in my dissertation, as well as several less persuasive attempts while working in the State Department and since perhaps less cogently) tried to make an important point, the truth of which knee-jerk free traders seem not to comprehend. As quoted by Kuttner, Lipsey and Lancaster say, "Despite the theoretical promise that free markets will be perfectly efficient, the real world is not a textbook. It is full of necessary distortions, and piecemeal attempts to move closer to a pure market may make things worse [my own precise point in my dissertation]. Therefore we are often better off finding the most advantageous "second best" position rather than looking for an unobtainable first best. The 1980s, alas, are replete with proofs of the theorem." This point was entirely overlooked by the WTO forum. Worse, it doesn't seem to be understood by the majority of the economics profession.
In addition to the Lipsey/Lancaster argument that chasing the will-o-the-wisp of pure Free Trade may, in the face of the stubborn protectionism of others, only result in making matters worse, (a logic which when I made it in a series of letters to The Economist Magazine a couple of years ago regarding another failure of the system, elicited a negative response from the Economist staff who -- as Keynes warned tends often to be the case -- seem to be mired in the conventional economic wisdom of a generation ago). I asserted (and reassert to you) that in seeking reasoned second best solutions, nations such as the United States should go on the offensive, actively considering carefully calculated departures from the Free Trade norm (examples: the Interest Equalization Tax (IET) and Domestic International Sales Corporation (DISC) legislation of the 1960s which had quite positive results). An even more telling example was the French decision a few winters back to counter Japanese defense of their domestic market against French goods by, in retaliation, designating Poitiers as the unique point of entry for Japanese VCRs -- and assigning only a couple of lackadaisical customs agents (taking the traditional three hour French lunch break) to process the tens of thousands of Japanese made VCRs trying to enter France in time for the Christmas season. The French got a quick reaction from Japan. As you once said (when a Presidential candidate), "When (one) stands up, others open up".
I have urged Ms. Barshevsky and other members of the US negotiating team -- and WTO officials -- to take a closer look at Second Best theory, adding Second Best to the Optimum Tariff and Strategic Goods arguments we were taught in grad school were the exceptions to the benefits of the theoretical Free Trade norm.. While readily agreeing that Free Trade would lead to the highest level of welfare in circumstances in which all or most nations of the trading world accept and practice it -- one can still insist that there are at present such substantial non-quota, non-tariff barrier departures from the Free Trade norm (e.g. the Kodak case) that attempts by a few dedicated free traders to apply the norm as "role model" in the real world can have decidedly perverse results. Indeed, it may result in distorting the world economy to the point that nations having a less comparative advantage may displace economies with greater comparative advantage. Beyond this, theory assumes instantaneous adjustment to the new equilibrium. In the real world, such adjustment can be slow because of recognition lag -- leading to painfully protracted unemployment and wasted plant and equipment. In a way this is good. Under prevailing theory, invasion of one's market by a better or cheaper product would result in the challenged firm immediately being forced under. With some friction in the process management can often recognize the problem, take remedial steps, and fight back. Example: the Chrysler Corporation which survived as a result of a federal loan, and which is today among the more efficient automobile manufacturers in the world.
I remain personally convinced that we have been too patient with regard to Japan's foot dragging. Every time we get some kind of agreement, they change Prime Ministers and it seems we must start over.
Following its recovery from the war (during which period its protectionist behavior could be understood and accepted), Japan has continued to protect both its industry and agriculture against the far lower prices of American rice, citrus products, and meat, as well as American (and European) cars, electronics goods, and a wide variety of other products, not to mention persisting with its many sometimes quite esoteric non-tariff barriers. In the early '70s the American television industry was virtually eliminated by reason of Japanese predatory pricing and the slowness of Washington to recognize the problem. I was personally intrigued by the results obtained when, as already noted, France gave the Japanese a whiff of its own medicine, requiring for a time all Japanese VCRs to be cleared through a unique customs post in Poitiers. The U.S. and Britain would never do such a thing out of sense of obligation to uphold Simon pure Free Trade, whatever the costs to themselves.
The U.S. has been slow in waking up to the situation (in good measure due to you) -- but we haven't quite yet got the theory right on what is happening or why. Perhaps this is because we are for the first time trying to understand a problem with which we are unfamiliar. Some years ago we began negotiations with the Japanese with regard to what is being called the "Structural Disparities Initiative", which seems to add up to our asking the Japs to quit being so efficient in manufacturing cars and VCRs , rather than getting them to open up their markets to competitive US and European products. And what say professional economists about that economically enlightened strategy? Perversely, they applauded it!
What I suggest are various forms of clever delaying counter-tactics a la Francais to hold some of our market for domestically produced goods, and accompanying jobs,which in a true Free Trade world might be able to survive, but when faced with a closed Japanese (Korean, Taiwanese) market(s), predatory pricing, and dumping tactics to gain market share, are forced to go under. And such second-best measures should be kept in place until the offending trade partner(s) open up, if ever they do. Then, however efficient their production of certain lines of goods, so be it. We'll all profit from their efficiency according to solid Free Trade logic.
I've already alluded to your remarks during your Presidential campaign about the $5,000 Chrysler "K" car which could not sell in Japan by reason of Japan's enormous tariffs which increase its price to $48,000. As you then said "When we stand up, other countries open up". We're now confronting a second barrier to trade: the zaibatsu of banks, factories, and retailers have succeeded in keeping American car showrooms as limited as possible so Japanese buyers hardly have access to them. Two years ago Japan, under great pressure, finally agreed to admit citrus products and meat (though in accord with its normal delaying tactics it has been dragging its feet ever since). And, while one hoped at the time it would also open up its economy to rice and other products as well as banking and financial services, these hopes after two years of stalling have yet to materialize.
Playing tough does get results! When I was American Alternate on the OECD Invisibles Transactions Committee in the late '60s I remember similar footdragging with regard to the sale of American movies, insurance, and the use of land/sea-going pickaback shipping containers on the part of our British, French, and Belgian trade partners. Fortunately there's been much movement in these fields since, primariuly because of US willingness to use such tactics as the Interest Equalization Tax (IET) and Domestic International Sales Corporations ( DISCs).
Not withstanding the Economist' s opinion published following receipt of my letter or the lack of understanding of the WTO in the recent hearings, one should not consider Second Best arguments "protectionist". I, and I think Kuttner and Lipsey and Lancaster, would see them as actually counter protectionist, reinforcing the belief that both protectionism and doctrinaire free trade in the face of protectionism, lead to third best situations. When one's competitors won't listen to reason while maintaining a protectionist posture for themselves, it makes sense to impose some calculated departures from the Free Trade norm to arrive at a second best situation in which not only national, but international welfare is improved -- if, unfortunately, not to the full Free Trade level.
What is paradoxical in introducing Second Best departures from the Free Trade norm, is that one not only improves one's own welfare by a smidgin less than the ideal, but one also improves the welfare of one's trading partners by compelling them to offer their consumers better and cheaper imported products. Thus, unlike the Krugman situation in which a country can benefit by subsidizing enough to discourage its partners from producing a given product, in the case of Second Best, both sides win by a shift in the direction of natural comparative advantage. Indeed, one hopes that seeing this improvement, the offending nation(s) may lower its/their trade barriers so that we can move on towards the Free Trade ideal. This important third point is not made in the Kuttner Business Week article, or, so far as I am aware, in the Lipsey/Lancaster Second Best paper. Professor Caves in approving my PhD work accepted it as my own contribution to economic wisdom.
Of course, as is usually argued against this approach, is that there is always the possibility of unreflective retaliation, which would then return us to a third (or worse) best situation. This is what some in Congress may threaten in response to the unrelective WTO decision and because our Trade Representative has been reluctant to use the 301 tool already provided. But there is no good argument to put up with the discrimination of trade partners apparently determined to take indefinite advantage of the good will of the US and Europe.
So at this point, it is probably worthwhile looking at the economic cost of a situation in which some of trade partners do retaliate to reasonable US second best initiatives. The Washington Post National Weekly edition (Vol 7., No 21, p. 23) published an article by Paul Krugman entitled The Surprising Trade Offs of Trade Wars , in which Krugman calculated the cost of a 100 per cent tariff in each of the three major trading blocs, reducing imports by a high-side estimate of 50 per cent, at 2.5 per cent of world trade -- less than 0.75 per cent of world income!
The real problem , as I see it, is not the countermeasures which might (or might not) be undertaken by those offended against, it is the protectionism in conventionally unrecognized forms by others (an especially important example being Japan's monopsonistic distribution system, which is only now coming to be understood as the fundamental reason U.S. products, whatever their theoretical competitiveness, cannot find markets in Japan). This failure in comprehension is understandable: the world has historically been troubled by monopoly, not monopsony, which perhaps has left us at a disadvantage both in recognizing and dealing with the Japanese challenge.
The problem has been reinforced by U.S. pride; i.e. our unwillingness to compromise with principle through adopting countervailing measures to achieve a Second Best optimum in an imperfect world. In politics it is widely understood that "the perfect is the enemy of the good", and compromise is the order of the day. For some reason, perhaps because economists think that unlike Political Scientists they possess "hard theory" and can thus identify the "perfect" with some precision, we seem less willing to compromise in the interest of achieving the mere "good". Recognizing that our Post-WW-II role as idealistic schoolmaster for world-wide Free Trade has met with less than universal success is, in a way, it seems, as hard on our self-esteem as admitting forthrightly that we lost the Vietnam War. It has in any event been costly for U.S. workers and U.S. industry despite our admirable record of having created as many new jobs in the past decade as all Europe and Japan combined and having kept the last expansion going for an unprecedented nine years. But whatever one chooses to call it, it remains rationalization when, deliberately or otherwise, one avoids recognition of the bad to emphasize only the undeniably good.
Sincerely,
David Timmins, PhD (Harvard)
Professor of Finance & Economics, Webster University - Geneva Campus
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