The Concise Guide to Economics: Free Trade vs. Protectionism

conciseguidetoeconomics.com ^ | Unknown | Jim Cox

[Luis Gonzalez]

Free Trade vs. Protectionism

Economists of all schools recognize the value of free trade:  greater overall production.  This greater production is due to the freedom of each producer to specialize in that line where he or she has a natural advantage.  The natural advantage of each trading partner results from the differences among people and locations.  A major reason the U.S. economy is as productive as it is, is that there is a large geographic area of free trade (the U. S. Constitution wisely prohibits protectionist tariffs and quotas among the various states).

Adam Smith enunciated the principle that it is foolish to produce at home that which can be obtained more cheaply abroad.  This is true not only literally of the home, but of the county, state, region and country as well.

This emphasizes that there is no distinction between trade and international trade in principle--one "exports" his labor to "import" goods consumed, as it is a cheaper means of obtaining goods than producing the consumed goods directly.

Despite the value of free trade there are continuous calls for disruption of an international division of labor by way of taxes on imports (tariffs) and numerical limitations on imports (quotas).  Such arguments are ultimately special interest pleadings advanced for the sake of a transfer of income to the special interest at the expense of the rest of the economy.

Henry George summarized the fallacy of protectionism this way:  "What protection teaches us, is to do to ourselves in time of peace what enemies seek to do to us in time of war."

A review of the seven most common protectionist arguments and their rebuttals follows:

Military Self-Sufficiency

This argument claims that some vital military goods may be unavailable from other countries in time of war and therefore a viable domestic industry is necessary for defense.  A true concern with such a scenario, however, can be dealt with by means of stockpiling the needed goods.  Such a stockpiling program would leave the consumer still free to shop the world and not disrupt the international division of labor.  One must suspect many such arguments when those making the argument are the very firms supplying those goods.  Examples in recent U. S. experience include even wool socks and steel--goods with easy substitutes and existing viable U. S. production. 

Further, a program of reducing taxes and regulations would allow continued viable U. S. production.  As is so often the case, any concerns should recognize the violence done to the U. S. economy by current policies and the fact that it is economically more efficient and just to reduce, not compound government interference in the market.

Protection of Domestic Industry

The fallacy of such claims is that the protection of any U. S. industry is to that same extent a detriment to other U. S. industries.  Protectionism against steel imports, for example, harms American firms which use steel as an input in their production process--auto, washing machine manufacturers, all firm's transportation expenses, etc.

Employment Protection

As Milton Friedman has stated, "we work to live, we do not live to work."  The concern should be with our production, not its means--employment.  Tariffs and quotas to protect American employment reduce our standard of living as we engage in lines of production that are not the most efficient in providing for ourselves.  The move to free trade which would reconfigure employment patterns in the U. S. would not be necessary except for the artificial pattern currently existing due to those tariffs and quotas.  In other words, the loss of employment in certain lines of work which would undeniably occur with a movement to free trade are due to the current absence of free trade.  These particular jobs would not have been created in the U. S. if policy had been one of free trade in the first place.

Diversification for Stability

Though this argument has little application to the U. S. economy, it is often used for say, Chile  which is heavily dependent on copper exports.  The fallacy is that Chile has a strong advantage in copper production and to forcibly diversify would be to pay dearly in opportunity costs.  Individual entrepreneurs should make these decisions according to their own assessments.  (On an individual basis this may be like cautioning a surgeon to find other means of  making a living.  While this would offer protection against the risks of being unable to perform as a surgeon the lost income in pursuing say, training as a lawyer would be vast.)

Infant Industry

Again this is not a currently fashionable argument for modern day America.  But the basic notion of protecting new industries competing with established foreign firms until they can "mature" and compete toe-to-toe is still false.  In effect, this suggests the substitution of government officials' judgment for that of private investors.  A truly viable firm can find investors who will be willing to absorb losses--as a form of investment--for the sake of the future profits to be earned.  This is in fact routine in the market as most new businesses or products earn losses in the early stages yet investors still see merit in such investments.  The fact that such firms are not currently successful in attracting investors voluntarily is strong evidence that there are no future profits to be earned.  Whose judgment would be superior:  private investors with their own money to lose or government officials with no personal financial stake in the outcome?  If in fact this was a truly valid argument for protectionism, it would logically be applicable not just to domestic firms competing with established foreign firms but to domestic firms competing with established domestic firms--a special tax on NBC programs for the sake of newcomer FOX, for example?

Dumping

There are two versions of dumping.  The first is selling products abroad at lower prices than at home.  But this is to be expected.  Buyers are normally more loyal to domestically produced goods (all other things held constant of course) than to foreign made goods.  The only way to successfully sell to foreigners is therefore with price concessions.  (Because of this loyalty factor, it would be strange if dumping was not the norm.) 

A second version of dumping is a subsidy to firms to sell abroad.  Naturally, American firms complain about such practices by other nations.  (And this is not to say that American firms receive no such subsidies--as special interests using the power of government for their own financial gain, it is common.)  If other countries do subsidize their sales in the U. S. then they are making a gift to American consumers.  While this is not wise for the sake of the economy doing the subsidizing, it is not right to correct the situation by punishing the American consumer with tariffs and quotas.  A consitent application of a prohibition of gifts  would prohibit samples!  The analogy often cited in other countries resorting to this form of dumping is to consider each economy to be a man in a lifeboat.  The lifeboat is the overall standard of living in the world.  If one person in the lifeboat foolishly takes out a gun a fires a hole into the bottom of the boat, the last thing others should do is to retaliate likewise with additional blasts to the boat bottom!  Compounding mistakes is not a solution.

[Luis Gonzalez]

Consumer electronics are cheaper today than in 1974, gas (even at the current level), was more expensive in 1974, cars are cheaper today than in 1974. Those are just starters.

[Luis Gonzalez]

And you want the Us government to traet its citizens like China.

That makes you a communist.

You should have listened to your mother: "So, if Johnny jumps off a building, you should jump off that buildng too?"

[1rudeboy]

For the first time since the 1960s, U.S. productivity has been growing at an annual rate above 2.5 percent. As numbers go, this may not seem spectacular, but it has enabled the economy to sustain a very low level of unemployment--less than 5 percent in each of the past three years--while holding retail price inflation to about 2 percent a year. The late stages of most business cycles put irresistible pressure on employers to raise wages, which ordinarily leads to increased prices and in turn acts to slow or stop the expansion. But in the present circumstances, employers can raise wages without upping prices because of increased productivity.

According to the President's Council of Economic Advisers, about half of the increase in productivity since 1995 is explained by increased capital equipment--particularly computers and software--plus increased productivity in the computer-manufacturing industry. The remaining half of the productivity increase may reflect new efficiencies from Internet use by business and the normally greater efficiency of employees during periods of high demand.

The better educated benefited the most from the rise in productivity. Average hourly earnings in private, nonagricultural business increased in real terms by about 16 percent during the past 40 years, but professionals did better: physicians, for example, enjoyed an increase in real earnings of 33 percent in the same period. One way of looking at the benefits of rising productivity is to compare various family income groups. The top 5 percent of families had an increase in income of 129 percent in real terms from 1960 to 1998, while the middle fifth had an increase of 54 percent and the bottom fifth only 38 percent. Family income went up not only because productivity was greater for other reasons, such as the increasing number of wives taking jobs outside the home. The average real income of working Americans, as the chart shows, increased beginning in 1995--undoubtedly made possible by the spurt in productivity over the same period. [emphasis added]

Source: Scientific American

[1rudeboy]

oops . . . the above refers to the period up to the year 2000.

[edsheppa]

Good post, but there's no way you'll get through to them. They've invested a lot in doom'n'gloom and won't let go. It's like arguing with creationists.

[Libertarianize the GOP]

bump

[american spirit]

That's very good info but it does neglect an inescapable yet never discussed facet of this whole debate and that is the explosion of debt at all levels since free trade became a front and center issue. I've been in the com'l/military electronics business since the early 80's and that's about the time frame I recall major concerns being expressed about the path we were embarking on at that time. (I'm sure the debate started much sooner but I do recall fierce discussions about Asian penetration at that time).

Here's the point....according to the Federal Reserve's own figures, since the early 80's corporate debt has gone from a little over 1 trillion to approx. 5 trillion in about 20 years....that's five-fold increase. What's more household debt went from a shade under 2T to almost 10T in the same time frame (5X). Also, fedgov debt went from a little over 1 trillion in '83 to the current 7 trillion they're willing to publicize and the over 40 TRILLION in "unfunded liabilites" that they're somewhat reticent to discuss....anyone heard any discussions on this fact during the debates? (I think not).

Of course there are numerous reasons for the dramatic increase in those numbers but it's undeniable that if free trade policies had delivered the wealth creating possibilities we were all left to believe would be created, those levels of debt would not be even close to what we've witnessed. It doesn't take a rocket scientist or even a free trade cheerleader to figure out that the explosion of debt has masked the debillitating effects of a flawed policy that will wreak havoc on future generations of Americans....and all the name calling and swarmy remarks cannot change that UNDENIABLE FACT!

[greenwolf]

So, did slave labor and thatch huts just get invented?

We seem to have been doing just fine competing in that world up to now.

The civil war was fought over tarrifs and industrial policy. If Abraham Lincoln had believed in Adam Smith, the civil war would not have happened. The fruits of those policies coupled with our free internal systems propelled us to world dominance and, for a period of time after WW-II, we were the only nation on earth left with a manufacturing capacity which was still relatively intact.

ANY theory could look good under those circumstances, but circumstances change. And, unless republicans get some sort of a handle on present realities involving jobs and outsourcing and the like, their circumstances are going to change too...

[upcountryhorseman]

According to the Economic Report of the President, 1991; a chart showing Trade/GNP Ratio and National Productivity Growth indicates that, starting in 1973, productivity growth
declined as the trade/GNP ratio increased.

Real wages have declined because since 1973 we have converted to a service economy and lost manufacturing jobs:
manufacturing jobs paid more than service jobs, consequently, two-job households became necessary.

[Luis Gonzalez]

"It's like arguing with creationists."

I have a very simple answer to that debate: God created evolution.

[Luis Gonzalez]

1974 per capita income US $ 5,676.00
2002 per capita income US $30,941.00

American Institute for Economic Research Cost of Living Calculator results:

$5,676.00 in 1974 equals to $20,712.22 in 2002.

$5,676.00 equaled a $109.15 a week salary.
$30,941.00 equals a $595.02 a week salary.

Ten gallons of gasoline in 1974= $5.28, or 4.8% of weekly salary.

Ten gallons of gasoline in 2002= $15.10, or 2.5% of weekly salary.

Things ain't as you say they are.

[neutrino]

Post proof of America's protectionst past.

Why sure, Luis. I'm glad to help educate you on the errors in free traitin.

You can also find the data at http://home.netcom.com/~rdavis2/tariffs.html

Enjoy!

[1rudeboy]

Please correct me if I'm wrong, but doesn't that chart show a lowering of tariff rates contributing to the greatest expansion of economic activity in history?

[dgallo51]

You can choose to wait, that's cool. I prefer ramming with an Abrams M1A1/2 :-)

[Luis Gonzalez]

Look at that...

Mmmm...

Tariffs rise dramatically, then suddenly THE GREAT DEPRESSION!!!!

Coincidentally, when they go back down...Great Depression over and "happy days are here again"!!!

Thanks form proving my point.

[Luis Gonzalez]

Hey Poohbah...check out neutered's chart on #52.

See the relation to high tariffs and the Great Depression?

[upcountryhorseman]

Regarding the real wages issue; Since 1973, when free trade started in this country, there has been a disconnect between
productivity and real income(1982 dollars). As productivity increased, real income decreased. This is shown by examining productivity and real wages from 1950 to 1990. From 1950 to 1973, productivity increased as manufacuring wages and average wages increased. But, from 1973 to 1990, as productivity continued to increase, manufacturing wages
and average wages both decreased.

[upcountryhorseman]

Convert this to 1982 dollars.

[upcountryhorseman]

Smoot-Halley was implemented after the depression started:
it didn't start the depression.

[natewill]

I wonder if anyone has read The Great Betrayal by Pat Buchanan. I had been a free-trade zealot for years, and Pat had some very thought-provoking stuff to say on the subject. Turned my opinions around 180 degrees. Our whole government structure was based on import duties, partly for protection of US industry, but partly because that's how we funded federal govt activities; there was no income tax. And I agree with whoever pointed out that Adam Smith was no more a part of the founding of this country than was Howdy Doody.