Economics Question

I recently took an exam which had the following question:

Which of the following is NOT a potential benefit from free trade policies by the US?
a) job creation
b) greater variety of goods
c) lower prices of goods
d) lower trade deficit
I believed that A was correct. Free trade by the US, usually involves more importing of goods produced by countries with cheap labor, such as China and especially Mexico. Many large corporations in the Us close their shops to produce products at such countries. These are just examples of course, but certainly enough to validate my point.

My professor however said it was wrong and that the correct answer is D. We argued for a while, and basically he said I can get credit if I can prove my point. Well I think that it’s pretty obvious that A is correct, or at least correct enough for there to be 2 right answers to the question. So my question is, what can I say to prove that I am right to my professor? (assuming I am right that is)

It’s a stupid question. In a narrow minded, short term view, the professor might be correct. However, the competitive dynamics change rapidly and the long term goal of US free trade policies is specifically to lower the trade deficit by encouraging other countries to open up. Job creation, in the short term, really wasn’t expected to exceed job loss (in spite of what some politicians may have said).

You might get some benefit from a discussion with the professor over short term vs. long term benefits from free trade, but in my experience, right or wrong, professors are always “right”.

FWIW, when I read the question I immediately picked D. We currently have something very close to free trade and our trade deficit is large and increasing. Maybe the professor was testing you to see if you were paying attention to what he was saying about the current world.

Or maybe he was assuming that the question pertained to the US, which by your own admission loses jobs (currently) to other countries. Your answer about job creation elsewhere therefore was completely opposite his point.

I guess this doesn’t help your case.

I didn’t realize economics had become an exact science…

I would’ve picked “D”, mainly because the question said “potential” benefit, not a “necessary” benefit. If you prof is coming from the standpoint that the US is the richest nation in the world and that free trade tends to increase our trade deficit, then it might be hard to argue. But given two countries with a trading relationship, both can’t have a worse trade defecit after a FTA is enacted.

I just looked up a few things. Here is an address by the President of the Dallas Federal Reserve Bank on why deficits are not inherently linked to free trade and are not that important:

http://www.ustdrc.gov/hearings/21jan00/rmcteer.pdf

Here is a Tompaine.com rant on why free trade causes deficits and will ruin the US economy:

http://www.tompaine.com/feature2.cfm/ID/8799

Perhaps your best bet would be to follow the line of reasoning from this article that originates with the Cato Institute:

http://www.bizjournals.com/wichita/stories/1998/05/25/editorial2.html

It asserts that trade deficits are primarily a reflection of monetary policy and economic growth rather than trade policies. The US, with the most successful and dynamic economy in the world attracts investment. These investment dollars must be utilized, leading to increased purchase of imported (and domestic) goods.

No, they aren’t, because you’re just looking at one side of the equation instead of considering the benefits of free trade as a whole. Free trade allows every country to concentrate its production where it has a “comparative advantage”, which leads every country to produce more and the world to enjoy a higher standard of living.

Even so, I’m not sure this translates into “job creation”, so I’m not sure your answer is wrong. In a world of autarky (no international trade) but no barriers to employment, everybody would still be working, but they’d be producing less and we’d have a lower standard of living.

Answer “D” is mostly correct, but the question is a little ambiguous. What does it mean for the United States to pursue “free trade policies”? If it means the US dropping tariffs and import barriers in isolation, this will usually lead to higher trade deficits, so the answer is correct. But if one takes “free trade policies” more broadly, to include negotiation with other countries to lower their own import barriers, then such policies could lead to lower trade deficits, and this would in fact be the goal of pursuing such a policy.

If I were grading the test I would grade answer “D” as correct, and I would allow credit for “A” only if you made the above case, which you have not done.

I guess maybe a better way to prove my point is to show a positive correlation between free trade leading to higher deficit and loss of jobs.
For instance, the increase in the trade deficit means that the US is importing more goods and exporting less, which means that there is a lesser demand for US goods, which means that factory workers will need to produce less goods, which means loss of jobs and work hours. Is this relationship feasible?

If you search on the internet you will find lots of groups like labor unions making that argument to bolster their opposition to free trade agreements. It’s a bit simplistic, but I think in the short term after NAFTA you can find some evidence for it.

Exactly, but I already know that. That was the basis for me choosing the answer in the first place. thanks though.

Unless you are prepared to spend a lot of time researching tariff schedules and import quotas, you will have a hard time quantifying the degree of “free trade” in place at any given time.

In any case, your economics professor is more likely to be moved by arguing in terms of economic theory, rather than political-style argument that “we did x and then something bad happened”.
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Yes, but it isn’t the whole story. We pay for imports in dollars. Foreigners must either trade those dollars for their own currency, or spend them on American exports, or invest them in dollar-denominated assets. Any of these actions can have repercussions on American jobs.

Anyhow, the question asked about the “purposes” of pursuing free trade policies. Economists have making the theoretical case that free trade improves living standards for about 200 years, so clearly, this is one of the “purposes” of such a policy whether you agree with it or not. Note, however, that I would have phrased it as “improving living standards” rather than “creating jobs”.

When you have a multiple choice question, presumably there is only one ‘correct’ answer.

Without assuming facts not in the question, d is the correct answer, it’s just common sense that countries will more likely place barriers to imports more often than barriers to exports.

An economic theory is that jobs are created by investment and greater profits(and therefore more job creation) will occur when capital shifts to more efficent industries from less efficent industries. Each country produces what it can the most efficently.

In practice, the US has few industries that can do that, one reason is the great difference in labor costs. IMO, the question was asking about economic theory, not the practical outcomes, because of the word “potential”.

The key to the question is the word potential. pontentially free trade could create jobs, you can argue about whether it actually has but potentially it could create jobs. Regarding your viewpoint on why A was correct, while you are correct manufacturing jobs are moving out of the country that is the whole point of free trade. Free trade allows countries to specialize in areas in which they have a comparative advantage, since developing countries can manufacture products more cheaply the goal of free trade is to allow them to take over manufacturing while the U.S. specializes in the areas in which they have an advantage such as the service industry. While this causes job losses for people in manufacturing jobs in the U.S. it results in a net increase in employment in both countries.

None of the answers have to be correct, but D is the most correct answer.

Free trade does create jobs, in the same sense that improving automation also creates jobs. It may displace jobs in the industry being automated, but the overall increase in productivity allows for job creation.

Now, it doesn’t HAVE to. There are no absolutes in economics. But it is a likely result.