Robert J. Stonebraker, Winthrop University
The Joy of
Economics: Making Sense out of Life
Robert J. Stonebraker, Winthrop
University
International Trade
Free trade, one of the greatest blessings a government can confer on
a people, is in almost every country unpopular.
...Thomas Macauley, English historian and
statesman, 1824
More than 150 years later, nothing has changed. Free trade remains unpopular – except among economists. We love it.
Modern countries rely heavily on international trade. We in the U.S. import from other countries about 15 percent of the goods and services we buy. We export a similar proportion of what we produce to other countries. While we trade with almost every nation in the world, because of its geographical proximity, Canada is our primary trade partner. Although this trade is a critical component of our economic success, it does create controversy, and many countries (including the U.S.) actively restrict international trade by imposing tariffs (taxes) and quotas (physical limitations) on imports.
Why? We make no attempt to limit trade between cities or states. Indeed, the U.S. Constitution forbids states to pass laws restricting trade with other states. Why should we not expand the “free trade zone” we enjoy within the U.S. to encompass the rest of the world?
Think back through the Annie and Laurie examples in the last section. By finding their comparative advantages, specializing and trading, both women improve their lot. The same logic holds for two countries. Substitute Austria and Liberia for Annie and Laurie. The examples still work. Both participants still gain from specialization and trade. Specialization and trade among countries creates the same benefits as specialization and trade among individuals. The logic of gains from trade does not stop at an international border.
We have made some strides toward freer trade in recent years. After rancorous debate Congress finally did approve our entry into the North American Free Trade Agreement (NAFTA) that mandates a phased elimination of all barriers to trade between the U.S., Canada, and Mexico, but opponents still abound.
Low wages vs. low productivity
Why? Trade critics most often play the cheap foreign labor card. During the 1990s debate on NAFTA, critics especially worried about the prospect of free trade with Mexico. After all, Mexican wages are much lower than those in the U.S. Would not Mexican firms, with access to so much cheap labor, be able to sell their goods at much lower prices than could U.S. firms? Trade critics warned that no American producers possibly could compete with Mexican firms. They warned that free trade with Mexico would create massive unemployment in the U.S. as American firms folded or moved south of the border to compete. Surely, they insisted, we must protect ourselves against cheap foreign labor.
No. We need no such protection. In fact, while American workers were frightened by the prospect of having to compete with the Mexicans, Mexican workers were equally afraid of having to compete with Americans. After all, American workers enjoy many advantages. American workers benefit from better education, better training and better health. American workers have access to more and better technology, to better communication systems, better roads and better community services. These make American workers more productive and enable us to turn out more goods and services per hour. While U.S. workers worried about low Mexican wages, Mexicans worried about high U.S. worker productivity.
The two factors cancel each other out. Work through an example. Suppose a Mexican worker can produce one bag of potato chips per hour and is paid $1 per hour. Suppose that an American worker is paid $10 per hour but, thanks to better technology and training, can produce 10 bags of chips per hour. Labor costs in both countries are the same: $1 per bag. The low Mexican wage is offset by lower productivity, and the high U.S. productivity is offset by the higher wage. Neither country has an advantage.
In reality, wages across countries are very similar when adjusted for productivity differences. When adjusted costs do differ, it typically is because of a comparative advantage. For products in which a country has a comparative advantage, its per unit costs will be lower. However, by definition, a country cannot have a comparative advantage in everything. If Mexico is comparatively better than the U.S. at one thing, the U.S. must be comparatively better than Mexico at another. Mexican prices will be lower than ours for products in which they have a comparative advantage; U.S. prices will be lower than Mexican prices on products for which the comparative advantage is ours. With free trade, each country will end up producing the products for which they have a comparative advantage; they will specialize and trade.
Winners and losers
Remember that the problem of economics is not to create jobs, it is to allocate scarce resources as efficiently and fairly as possible. Workers are a scarce resource. There always are more jobs to be done than there are workers to fill them. There always are more things that could be produced, if only we had the resources to do so. If the Chinese or the Peruvians or the Somalis are willing to sell us a product for less than it would cost to produce in the U.S. it should be cause for joy, not hand-wringing. Buying from abroad allows us to free up domestic workers to produce other products instead. It allows us to expand our production possibilities.
Free trade does not cost jobs, it reallocates jobs. That has been our experience. As we move toward free trade, we gain jobs in sectors for which we have a comparative advantage and lose jobs in those sectors for which we have a comparative disadvantage. For example, if the U.S. has a comparative advantage in farm equipment and Mexico has a comparative advantage in textiles, then farm equipment production will migrate to the U.S. and textile production to Mexico. U.S. textile workers would switch to farm equipment, and Mexican farm equipment workers would change to textiles. Unfortunately, people don't reallocate as easily in the real world as on a classroom chalkboard. Older workers who are displaced from textile jobs in the U.S. may be unable or unwilling to retrain and/or relocate to produce farm equipment instead.
Should we protect these potentially displaced workers from foreign competition? No. Trade will certainly create losers in this scenario, but trade remains the efficient option. The message of comparative advantage theory is that the winners win more than losers lose.
Suppose we do impose tariffs on Mexican textiles, what will happen? The U.S. textile industry will benefit. The tariffs will raise the price of foreign textiles and secure the market for American producers. U.S. textile firms will gain profits, U.S. textile workers will keep their jobs, and communities built around U.S. textile mills will enjoy more vibrant economies.
Unfortunately, the rest of America will lose. U.S. consumers will be hit with higher textile prices. This hurts individual consumers, but also hurts corporate consumers. For example, U.S. clothing manufacturers now must pay higher prices for their raw materials. This, in turn, will force them to raise clothing prices and put them at a competitive disadvantage with respect to clothing firms in other countries that have access to cheaper textiles. In other words, saving U.S. textile jobs might cost us clothing jobs. Moreover, to the extent that U.S. consumers must now spend more on textiles and related products, they will spend less on other products. Perhaps the increased prices of textiles mean we can no longer buy as much ice cream. If so, ice cream jobs will be lost as well. Statistical studies inevitably show that tariffs create more economic losses than economic gains.
Do you want another defense of free trade? Consider the following parable told in Greg Mankiw's Principles of Economics text (based on an idea originally attributed to economist David Friedman):1
An American invents a way to produce steel at minimal cost. The only input needed is wheat. After building a state-of-the-art mill in Iowa, she floods the market with new, low-cost steel. The cheap steel cuts production costs in many basic industries and spurs productivity growth and higher standards of living across the economy. Former steel workers are displaced, but eventually find jobs raising wheat or working in other, spin-off agricultural firms. The inventor becomes an instant celebrity and is feted by Democrats and Republicans alike.
Curious about this new technology, an investigative reporter sneaks into the mill and discovers the inventor is a fraud. The mill is empty. The "inventor" has simply been shipping the wheat abroad and using her proceeds to import low-cost steel illegally from other countries. When the true story hits the streets, government trade officials shutter the mill and throw the erstwhile celebrity in prison. Steelworkers return to their former jobs, production costs rise, and standards of living revert to earlier levels.
Congressional representatives send disclaimers to all constituents and media pundits heap scorn upon the now-disgraced hero. She was, they remind the masses, not the genius they thought. She "was just an economist."
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Notes:
1. Perhaps the most famous defense of free trade was provided by French economist Frederic Bastiat. His 1845 tongue-in-cheek Petition of the Candlestickmakers provides a classic spoof of the cheap foreign labor fallacy. The petition can be read at http://bastiat.org/en/petition.html
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Testing Yourself
To test your understanding of the major concepts in this reading, try answering the following:
1. Identify the percent of goods and services the U.S. imports and exports and identify our major international trading partner.
2. Critique the argument that tariffs are needed to protect American workers from cheap foreign labor. Discuss the role of productivity differences across countries.
3. Explain why tariffs on foreign goods benefit some Americans and hurt others. Who wins? Who loses? Why? How can tariffs on textiles throw ice-cream employees out of work?
4. Explain how we might efficiently produce steel with wheat.