BUSINESS FORUM: A TRADE PACT FOR CHIPS; Just a Fancy Form of Protectionism

SYNOPSIS: One of Krugman's first articles for the public on free trade

The recent semiconductor pact with Japan is the latest step in an accelerating retreat by the United States from its commitment to the principle of free trade. At this rate, within a few years virtually the whole of our trade will be ''managed'' under agreements that set limits on trade flows and market shares. A naive observer, who believed that governments mostly act in their own national interest, might think that there was at least a reasonable case for this change in policy. Unfortunately, there is nothing good to be said about the drift to managed trade. Managed trade is bad economics and an invitation to political abuse.

Let's start with the economics. Advocates of managed trade see import quotas and market-sharing agreements as ways to protect United States jobs. In fact, however, theory and experience both tell us that limits on trade do not add to employment. The jobs protected in one part of the economy are always matched by jobs lost elsewhere, either because other countries retaliate or because protection causes an overvalued exchange rate. The only net effect of trade restrictions is that we force our economy to do the things it does relatively badly instead of the things it does relatively well. But what about our trade deficit? Is the deficit not evidence that other countries are playing by different rules, and that we need to level the playing field? Here it is important to get our facts straight: The trade policies of foreign governments have not caused or even contributed to our trade deficit.

In fact, our trade balance has deteriorated across the board, with free-market West Germany as well as with allegedly protectionist Japan. Even the Office of the United States Trade Representative, an agency with a vested interest in stressing the importance of unfair foreign practices, admitted in its last annual report that trade restrictions had nothing to do with the rising deficit, which could be explained entirely by the strong dollar, the debt crisis and lagging growth in Europe and Japan.

The most important argument against managed trade is not, however, that it is economically inefficient. The real problem is that managed trade always ends up being managed on behalf of special interests. Quotas and market shares cannot be set on a rational basis, because no such basis exists. On the other hand quota-setting and market-sharing offer excellent opportunities to play politics. UNDER managed trade, the Government decides how much import competition an industry will face; foreign governments, negotiating with our Government, decide how much the industry will be allowed to sell in export markets. Governments are thus given an enormous pork barrel to distribute. Better still, the whole process is off-budget. Only a government of saints could manage trade objectively in such a situation, and that we do not have.

This is not just speculation. We already have managed trade in four major sectors (as well as many minor ones): sugar, steel, autos and textiles. Our policy in these sectors has been remarkably consistent, exhibiting a degree of political exploitation that has exceeded the expectations of the most hardened cynic. In each case the Government, in effect, has organized American and foreign producers into a cartel that raises prices at the expense of United States consumers. This makes domestic producers happy and buys off the foreigners, while the rest of the economy pays the price, which is in each case very high.

For example, a report by members of the staff of the Federal Trade Commission finds that in all three industrial sectors, the cost to the rest of the economy per job protected by import limitations is several times the income of the average worker in the industry. In other words, we would be better off retiring steel, textile and auto workers at full pay than protecting their jobs through managed trade. Sugar is even worse: Last year United States sugar prices got so far out of line with world prices that it was cheaper to extract sugar from Canadian pancake mix and Israeli frozen pizza than to produce it from domestic sugar cane.

When government policies produce the same adverse results over and over again, it becomes clear that the results are no accident. They are inevitable when we put the detailed management of trade into government hands. Once the Government is in the business of deciding how much sugar is to be imported into the United States, how many voters will be able to keep track of the relationship between their Congressman's votes and the price of soft drinks and ketchup? Naturally, it is the interests of well-organized producers, not the economy as a whole, that get served.

In future years, we will see many proposals to extend the pattern of sugar, autos and textiles to other industries. These proposals, like past efforts at managed trade, will serve special interests at the general expense. Lobbyists, and perhaps a few academic hired guns, will deny this and claim that managed trade is good for the country as a whole. It isn't.

Originally published in The New York Times, 8.10.86