A Math Example Clarifies The Debate About Free Trade

Sharpen your pencils, get a cup of coffee, and grind through this simplified math example that clarifies why jobs are being lost to places like China and India through free trade.  Hopefully the exercise will be enlightening.  It also explains mathematically why America must innovate to make up for lost jobs and to keep wages from being depressed.  If you have any questions while going through the exercise, leave it in the comment section and I will promptly answer it for you.

The Debt Ponzi Collapse Exposed the Real Crisis: A Transfer of Investment and Jobs

Notwithstanding that the current economic crisis was initiated by a debt ponzi scheme that collapsed inflated home prices, creating credit and capital illiquidity, the real crisis is what the collapse finally exposed.  Over the last 25 years, a series of bubbles and bursts have masked the underlying long term transfer of investment and jobs from America to other countries.  The following is an extremely simplified but useful example of how this occurred and why debate continues to surround free trade.

Assume:

• 2 countries X, Y
• 10 people per countries X and Y
• 1 International banker / multinational company (Banker)
• 10 products each requiring 1 person /year of work
• Products expire in 6 years requiring replacement
• Capital has infinite life, interest rate is 0%, material and transportation costs are free

 

Country X

• Banker lends to multinational who creates 10 factories
• 10 Factories each hire 1 person to create a total of 10 products per year
• Workers are paid 1 dollar for each unit of work and products are priced at 1.2 dollars
•  At the end of each year, each person borrows .2 dollars and buys 1 product
• After 6 years, all people have earned labor wages to pay back loans and own 5 products
• After 6 years, 60 units are produced and 50 are consumed
• In 6 years, Banker nets 10 units, zero dollars (60 dollars revenue less 60 dollars) labor, and creates  2.4 dollars value per factory
• With excess units, Banker seek more consumers
• Some products are already reaching obsolesence so cycle must repeat

 

Country Y

• For first 6 years country Y is agrarian but educates its people preparing for industry
• With high unemployment, workers are willing to work for .2 dollars
• Country Y government collects .2 dollars for multinational privilege to invest in country Y
• After first 6 years, Banker builds a factory to produce 1 product (a)
• Banker hires 1 person and loans person 1 dollar to buy product (a)
• During next 5 years, factory produces 5 units and 1 is consumed by country Y, 4 units of product (a) are sold to Country X
• Banker nets 3 dollars, selling 5 units for 5 dollars, labor costing 1 dollar, country Y collecting 1 dollar
• Banker benefits .6 dollars by moving factory to country Y
• As capital is returned, Banker reinvests in country Y
• Country Y invests dollars gained by multinationals in securing future benefits for its people

 

Country X responds

• Because prices are lower, workers in country X buy 4 units of product (a) from country Y
• Plant producing product (a) reduces output to 1 unit during next 5 years
• Worker from factory (a) is laid off and replaced by part time worker
• Small company with innovative idea generates product requiring loan and worker
• Banker loans small company to build factory to produce product
• Small company hires worker that was producing product (a) so that employment is maintained

 

Over Time

• Banker corporation continues to invest in country Y
• Country X must continue to innovate to create new products to replace jobs taken by country Y
• The rate at which country X cannot keep up with the transition of jobs to country Y correlates to the rate at which jobs are lost and wages are depressed in country X

 

Benefits and costs of free trade to residents of Country X

• Workers who have jobs benefit .8 dollars over 5 years from buying lower cost product
• If innovation keeps pace with the transfer of jobs overseas, creating high paying jobs within country x, residents of country x receive more goods and are wealthier
• However, if the following occur, residents of country x is poorer, and country X borrows 2.5 dollars over 5 years from banker to pay unemployment benefits to laid off worker:

o   If innovation does not keep pace

o   If investment wealth is limited and bank receives higher rate of return for funding multinational transfer of jobs than on innovation investment

o   If multinationals purchase innovation and transfer innovation to country y

o   If economic shock creates illiquidity and halts investment in innovation

 

Benefits and costs of free trade to Banker / multinational

• Under scenarios listed above, the banker / multinational continues to benefit

o   With innovation, banker has additional investment options

o   Without innovation, wealth of the working class is transferred through multinational transfer of jobs to the banker

• However, if free trade and excessive investment in country Y cause jobs to shift too quickly, then:

                o   Country X deficit increases to unsustainable level

o   High unemployment in country X causes widespread default on consumer loans

o   Banker / multinational is at risk of negative return

China and India are Winning the Jobs War

China and India are winning the “jobs war”.  American jobs are being lost most to developing countries where the average wage is less than $3,000 per year. What is the impact of trade deficits on jobs? With a trade deficit of about $700 million, and with about 45% of trade volume representing labor and private sector multipliers of 2.0, America’s trade deficit represents about 14 million lost American jobs. 

Do trade deficits harm America? Since the average income for major trade surplus countries is under $3,000 versus the average American at $43,000, many products overseas can be manufactured at far less costs than in America. If all wage differences were passed back to American consumers, our consumers would benefit from lower prices by about $280 billion. But if we net out the loss of $630 billion in lost American wages, America still loses $350 billion every year. 

Which Americans benefit and which are penalized by trade deficits? Laid off workers lose because they collect only a portion of their wages in unemployment. Their unemployment payments are paid by all Americans, so taxpayers lose. Lower wage consumers benefit more by lower prices than by the taxes that they are required to pay, so their households benefit perhaps as much as $2,000 a year. Of course in the long run, trade deficits are borrowed, causing loan rates to go up for both consumers and government, so all America is penalized. 

Does freeing up trade benefit America? Certainly, more American goods and services can be sold to other countries and more foreign goods can be purchased by American consumers. However, unless our government negotiators are savvy enough to remove specific trade restrictions that will reduce our trade deficits, the large differences in wages between America and developing countries would suggest we will not benefit from more free trade. 

Freeing up trade should grow the volume of trade, and therefore the trading class should benefit. The working class American who has a job may also benefit from some consumer savings at the expense of all Americans. Of course, many Americans who no longer have jobs will not benefit. And until the rest of the world’s wages catch up to America’s, or free trade increases innovation to allow Americans to purchase more goods at less cost, it seems that for a period to come, America will lose financially.