Free Trade, Tariffs and Quotas

In this episode, Rik from Planet Vulcan demonstrates that the notion that international trade amounts to warfare that someone wins and someone loses is another of those pervasive undead ideas on Planet Earth that keep rising from the grave, wandering the land and eating brains.
In truth international trade is an unalloyed benefit to consumers in all countries simultaneously, both because of comparative advantage and because it subjects producers to greater competition.  
And while it's generally true that consumers are also producers, it's also generally true that what the typical Earthling producer loses by having to face competition is far less than what the typical Earthling consumer gains as a result of free trade, especially when you consider the long-term systemic effects of tariffs and quotas:  stagnation and decline.
Protectionism ought to be regarded as anti-social and uncivil.

Transcript

Free Trade, Tariffs and Quotas

Good day to you, and welcome to Fascinating!  I am your host Rik, from Planet Vulcan.  My continuing mission on Planet Earth:  to search for signs of intelligence and to encourage its spread.

 Earthling economists have seldom reached general agreement about anything for very long.  An exception to this rule is the near-unanimous agreement among these economists on the benefits of free trade.

 Let’s take a minute or two to review just what the benefits of free trade are said to be.

 First, both trading partners gain from trade because of comparative advantage.  

 Earthlings have the brilliant 19th century economist David Ricardo to thank for demonstrating how comparative advantage sets up opportunities for mutually beneficial trade, and for demonstrating how pervasive comparative advantage is.

 To understand why, you must first distinguish comparative advantage from absolute advantage.  Even when someone has no absolute advantage at anything, they virtually always have a comparative advantage at something.

 Ricardo explained the concept using an example involving two countries (England and Portugal) and two goods (wine and cloth):

 Suppose both wine and cloth can be produced more efficiently in Portugal than they can in England, meaning that Portugal requires fewer resources than England requires to produce either good.

 However, if we look at it from the angle of opportunity cost, the cost of producing wine, in terms of foregone cloth production, is lower in Portugal than in England, i.e., Portugal gives up less cloth production to produce more wine. 

 Conversely, the cost of producing cloth, in terms of foregone wine production, is lower in England than in Portugal, i.e., England gives up less wine production to produce more cloth.

 Therefore, Ricardo argued, both countries could benefit from specialization and trade: Portugal should specialize in producing wine (where it has a comparative advantage, not to mention better grapes), and England should specialize in cloth production (where it has a comparative advantage, even though it does not have an absolute advantage).

 By specializing according to their comparative advantages and engaging in trade, both countries can consume more of both goods than they would in a situation where each tried to be self-sufficient. 

 This insight shows that even if one country is more efficient at producing all goods, it can still benefit from trade with less efficient producers.

 Secondly, and even more importantly in the long run, free trade subjects producers to greater competition, which benefits consumers.

 And there’s the rub:  producer interests and consumer interests are at odds, and producers would just as soon not face competition; so they tend to embrace “protectionism” and try to sell it.

 They also lobby for it, and as the distinguished American economist Mancur Olson pointed out, a small cohesive group can exert more influence on policy than a larger group with more diffuse interests. 

 Thus a smaller group of producers are often more effective than a larger group of consumers at putting protectionist policies that harm consumers into effect.

 To sell the notion to consumers, producers need to obfuscate, distract and reframe.  

 How do you as a producer convince consumers that they, and not you, are being “protected” when you advocate policies that result in higher prices, lower quality and narrower choices for them?

 A tried-and-true method is to frame international trade as a “war” that someone wins and someone loses.  It’s “Be true to your school!!” all over again.  And you can be proud when “your” domestic company defeats a foreign company.

 Another method frequently employed is to tell people that they will lose “their” jobs to workers overseas who work for lower wages and who are perhaps not subject to the same labor or environmental regulations.

 And while it is true that competition from overseas can disrupt domestic labor markets, it is likewise true that domestic competition can disrupt labor markets.  Earthlings are far better off in either case to just roll with the punches and to view problems as opportunities.  The alternative is stagnation and decline, such as we are currently witnessing in countries outside the United States that are built on protectionist policies of various sorts and tight regulatory control.

 Proponents of protectionism often cite the need to counteract unfair trade practices by foreign competitors, such as dumping (selling goods at below-market prices), currency manipulation, or government subsidies that give foreign firms an “unfair” advantage in the market.

 A moment’s thought ought to leave you convinced, however, that these allegedly “unfair” trade practices would chiefly harm foreigners, who would in effect be subsidizing domestic consumers by engaging in such practices.  This argument has no more validity than the argument about “predatory pricing” in general.  

 Protectionist measures are also sometimes promoted as a means of reducing trade deficits (which is defined as importing more than you export). The ostensible aim of imposing tariffs or restricting imports is to encourage domestic production and reduce reliance on foreign goods, thereby balancing trade accounts.

 In fact there is no such thing as a trade deficit.  It is simply not possible to import more than you export.

 The so-called trade deficit is an artifact of the practice of arbitrarily dividing foreign trade into “current”, or short-term, accounts and “capital”, or long-term, accounts.  These current account deficits, which are framed as something to be alarmed about, are automatically offset by capital account surpluses, and there is no cause for alarm.

 Of late, some proponents of protectionism have advanced the argument that a tariff in reality can be a good thing, citing as evidence that even though the United States had high tariffs in the late nineteenth century, economic growth was impressive.

 For an Earthling whose mind is already made up, this argument is convincing, and there doesn’t appear to be any need to investigate further, even though to a scientific mind the argument is not conclusive.

 Careful investigation of that era by serious economists has revealed that the high tariffs actually did have the deleterious effects that economic theory predicts; and they have concluded that economic growth without the tariffs would have been even more rapid than it was with the tariffs.

 If you still need further convincing that protectionist tariffs are a bad idea, I suggest you follow this reductio ad absurdum scenario.  

 Start with the hypothesis that, for purposes of argument, Earthlings in one country need “protection” from competition by Earthlings in other countries.  Why then do they not also need protection from competition by Earthlings in other states within the United States?  And how about protection from competition by Earthlings in neighboring counties and cities?  How about those Earthlings on the other side of town who are taking your job?  

 And ultimately from this point of view, why should you trade for anything with anyone?  Become totally self-sufficient.  And if you believe that having a job to work at, and not consumption, is the ultimate good, I guarantee you that you will have plenty of jobs and plenty of work.

 Absurd enough for you?

 I invite you to have a listen to the next Fascinating! podcast and a look at the next video on our YouTube channel, Fascinating@pregodenada.

 Please recommend Fascinating! to your friends if you find the lessons from nature in these essays personally valuable.

 Theme music:  Helium, with thanks to TrackTribe

 Live long and prosper.

 Practice the art of winning without defeating anyone.

 Savor your experiences and treasure your memories.

 Look forward to a happy and rewarding future.

 And respect nature’s wisdom.