When It Comes to Free Trade, the Market Doesn't Always Know Best

Yahoo

28-03-2025

The global trade war initiated by U.S. President Donald Trump is heating up. Having already imposed tariffs on a host of goods coming from some of the United States' biggest trading partners, Trump upped the ante this week by leveling a 25 percent duty on imported automobiles and parts, to take effect April 3, and more tariffs could be announced next week.
Overall, just nine weeks after Trump returned to the presidency, the average U.S. tariff has already risen to its highest level since 1946, approaching 'Smoot Hawley' levels of protectionism. In response, countries are altering their own trade policies vis-à-vis the U.S., with some retaliating by raising their own tariffs on U.S. goods and others canceling existing trade arrangements, such as participation in the joint production of the F-35 fighter, due to broader concerns over Washington's dependability as an ally.
Not content with impeding trade, however, the Trump administration is also planning widespread restrictions on the flow of people into the U.S., from an extensive travel ban to reversing the inflow of undocumented immigrants with mass deportations. As with trade, the Trump administration is not alone in restricting the flow of people, with countries around the world, notably in Europe, making it harder to acquire visas amid a growing reluctance to accept refugees.
The sand thrown into the gears of the global economy goes even further. In addition to restricting the flow of goods and people, the Trump administration is also putting forward an America First Investment policy to restrict the country's traditionally open financial markets. For now the new measures impede only investments in strategic sectors by individuals and entities associated with China and other listed 'adversaries' of the U.S., while doing the same for U.S. capital flowing out toward them. But those countries—and any others that are added to the list—could respond with their own capital controls.
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These restrictions on international economic flows seem, at first blush, to be obviously bad. After all, according to standard economic principles, eliminating these barriers allows the forces of supply and demand to do their work, bringing about efficiencies that optimize economic wellbeing in all the societies participating in global trade. Imports allow more variety, and less expensive goods will benefit consumers. Capital inflows will offer a greater supply of investment to stimulate growth. Meanwhile, immigration means a growing population, which can serve as the basis for global power. Open economic policies, whether domestic or foreign, would seem to be unquestionably smart.
But is that really the case? Is an open economic system actually such a good thing? The answer is not as simple as standard economic theory would lead us to believe. This is because what a market needs to efficiently allocate goods and capital in the face of scarcity runs headlong into the desire of governments to exercise their sovereignty.
The reality is that the while free trade might be universally beneficial from an economic perspective, that is not the case from the perspective of political economy.
When governments around the world pursued policies that enhanced economic 'globalization' during the 1990s and early 2000s, many working-class individuals in industrialized countries—and the U.S., in particular—lost their jobs due to the resulting changes in domestic economies. As the international political economy scholars Jeff Colgan and Robert Keohane wrote years ago, the international trade system seemed 'rigged' against workers in the industrialized world, causing many of them to feel left behind by economic globalization. The resulting 'discontent' only grew and spread following the 2008 global financial crisis and the 'great recession' it caused, with works such as economist Thomas Piketty's critique of neoliberal policies, 'Capital in the Twenty-First Century,' soon making it onto best-seller lists.
What is notable is that such concerns over globalization's potential to go 'too far' did not newly emerge in the late 20th and early 21st century. Writing in the first half of the 20th century, the prominent British economist and diplomat John Maynard Keynes recognized that governments may have to resort to tariffs as a 'second-best' policy option to boost employment. Of course, Keynes was well known for calling on governments to intervene in economies.
But consider also the views of Friedrich Hayek, Keynes' nemesis. Known as a staunch advocate of free market principles lest society be led into 'serfdom,' Hayek was also a pragmatist. He did not advocate for full-on laissez-faire policies, largely because he feared that completely open flows of goods and capital would result in central planning. To prevent this, government interventions in the form of targeted restrictions might be necessary to protect the market from completely disappearing. In this sense, Hayek shared much with the father of economics itself, Adam Smith, who despite vaunting the 'invisible hand' of the market also acknowledged that judicious intervention by government into the economy might be needed from time to time.
The political blowback that can result from overly open economic flows is why the International Monetary Fund—hardly known for its opposition to free-market orthodoxy—has warned time and again about global imbalances in trade flows, by which some countries persistently run trade deficits while others persistently run trade surpluses. Trade deficits, and the continual flow of imports they represent, can feed protectionist backlash due to the perception of one country persistently taking advantage of another. Indeed, that is exactly the argument Trump makes.
Related, it would seem that eliminating restrictions on the flow of money and finance into and out of a country could be beneficial for encouraging investment and spurring economic exchange. But in the past, open flows of capital created disruptions in the international system that resulted in a series of global debt and financial crises, from Latin America in the 1980s to East Asia in the 1990s, before reaching the housing markets of the industrialized world in the late 2000s. These concerns about trade have, in turn, contributed to concerns about immigration. The political scientist Margarette Peters showed how open immigration and open trade cannot coexist. If you have one, it will inevitably create a desire to close off the other.
None of this is meant as a defense of Trump's proclivity for seeing tariffs as the right tool for solving every policy problem, foreign and domestic, or to 'sanewash' his idiosyncratic fixations by offering a rational explanation for them. Moreover, Trump could push protectionism and his coercive leveraging of the United States' privileged position in the global economy too far, causing a global economic collapse. But it is to say that the view of tariffs, capital restrictions and immigration controls as necessarily foolish impediments to the obvious efficiencies and benefits of the free market is also misguided. Trade wars aren't 'good and easy to win,' as Trump claimed during his first stint as president, but trade restrictions aren't obviously and fully bad.
That's because it's not 'just the economy, stupid,' as an adviser to former President Bill Clinton once famously put it in the 1990s heyday of globalization. It's the politics, too.
Paul Poast is an associate professor in the Department of Political Science at the University of Chicago and a nonresident fellow at the Chicago Council on Global Affairs.
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