In Episode 34, we saw that the practice of free trade according to comparative advantage
results in lower buying prices, higher selling prices, and greater global production, all
of which means improved living standards.
Do you know how many countries in the world are engaged in trade?
Every single one -- there's not one country in the world that's completely self-reliant.
And do you know how many countries around the world practice completely free trade?
None.
Not one single country practices trade free of any restrictions.
So if free trade is so fabulous, then why do all countries put restrictions in place?
Perhaps it's best to take one step backwards and ask: who has the power to put trade restrictions
in place?
That would be each country's government.
Why would the government put such restrictions in place?
The government places trade restrictions in order to protect domestic industries from
foreign competitors.
Now ask yourself this: which domestic producers would seek such protection?
Surely not all of them; some domestic producers already have a natural advantage in production
over the foreign competitors.
This is the key; the only domestic producers who would need protection are those who would
be driven out of business under free trade -- those who have a comparative disadvantage
in production.
So what arguments could the weak, disadvantaged producers make to the government to convince
it to provide protection in the form of trade restrictions?
Well, there are several.
First, there's the domestic jobs argument: if some type of trade restriction, say a tax
or a quota, is placed on incoming foreign goods, then consumers will have to purchase
domestic goods instead, right?
And if the demand for domestic goods is higher, then the need for workers to produce those
goods is higher.
Look at the US steel industry: with protections in place, more US steel is purchased, and
more US steel workers have jobs.
The domestic jobs argument is pretty persuasive with politicians, because voters with jobs
are happy voters.
Here's the rub, though; while trade barriers mean more jobs in the protected industry,
they actually cost jobs in other industries.
Think again about the US steel industry: historically, taxes (called tariffs), have been imposed
on imported steel, so the US producers don't have to compete at such a low price.
But this means that steel will cost more to consumer.
Who buys steel?
The auto industry, perhaps?
Construction firms?
Steel drum manufacturers?
Any industry that uses steel is a resource will face rising costs, which will lead to
decreased supply, which means fewer jobs in all of those industries.
So while steelworkers may have more jobs, workers and all the downstream industries,
like auto workers and construction workers, will lose jobs.
On net, especially in a country like the United States where disadvantaged areas tend to be
oh, raw materials are low-end materials, this will result in a net loss of jobs.
Argument for production number two: level playing field.
The logic here is that the foreign producer has some unfair advantage over the domestic
producer, and the trade restriction would just… even things up a bit.
An unfair advantage might be if, say, the foreign producer was receiving subsidies from
its own government, such that costs were reduced, and the foreign producer’s product could
be sold very cheaply in our market.
But what happens if the foreign producer just has an advantage -- are all advantages unfair?
In 1997, the collapse of the Thai baht kicked off a wholesale financial collapse in Southeast
Asia.
As Asian currencies lost most of their value, becoming very cheap, Asian products became
cheap.
Suddenly US steel producers were facing extremely cheap Asian steel, and went to the US government
to seek protection.
The question I have is this: did the Asian producers have an unfair advantage?
Did they deliberately plan for their currencies to lose over 90% of their value, just so they
could sell more steel?
The term “fair” is a slippery thing, somewhat subject to interpretation.
The other difficulty here is that one country may dispute the “fairness” of another's
restrictions, and retaliate with restrictions of its own, eventually escalating into a trade
war.
A third argument for trade restrictions is that they can raise additional revenue for
the domestic government.
A tariff (or a tax on imported goods) would generate added dollars, as would revenue from
the sale of quota licenses.
But in a country like the US, where only a very small percentage of government revenue
comes from traded goods (remember we saw in the budget episode about 90% of federal revenues
come from income tax, payroll tax and corporate tax), does it makes sense to harm consumers
by making imported goods more expensive?
The government revenue argument is likely to be more compelling for governments of poor
nations, where there isn't much income to tax; the only place to squeeze additional
revenue is from businesses, especially internationally.
A fourth argument used in favor of trade restrictions is the national defense argument.
If an industry is critical to the national defense, we should protect it in peacetime
to make sure that it's still around in times of war.
Some industries may spring to mind immediately as being critical to the national defense:
tanks, guns, munitions, aircraft, shipbuilding… but then, what about the metal used in all
of these industries?
Shouldn't that be protected?
What about our food supply, or uniforms for our troops?
Or the producers who make buttons for the uniforms?
You can see where this is headed -- it becomes difficult to draw a hard and fast line separating
industries that are critical to the national defense from those that are not.
This becomes compounded when you realize that in recent years, the argument has been broadened
from “critical to the national defense” to “critical to the national interest.”
For example, some countries have restricted the amount of US entertainment and publications,
like movies and magazines, that are allowed in, because they feel it would not be in their
country's national interest to allow their own cultural identities to be swallowed up
by US pop culture.
The infant industry argument is number five on our list; this says we should protect and
support new industries until they're mature enough to compete on their own.
I can understand this; in the town where I grew up there was an economic incubator.
If you had an idea for new business, you could put in a proposal.
If you were successful, you’d start up your business in the incubator building, enjoying
lower rent and immediate access to business consultants.
After a designated period of time, your business would move out and someone else would move
in.
Here's the drawback with federal support for a new industry: who is in the best position
to know when the industry is ready to “leave the nest”?
The industry is.
So if the government goes to the industry and says, “Hey, you ready yet?
Can we take the restrictions away?”, what's industry going to say?
“Sure, go ahead”?
More likely the response would be, “No, not yet.
Ask us again a couple of years.”
In the past, some countries would protect these “infant” industries for decades.
In the US, at least, the international Trade Commission (or ITC) places time limits on
protection, and usually weans the industry off by progressively decreasing the level
of restrictions over that time period.
There is one more method that goes against the natural flow of free trade, but it’s
less about protecting a weak domestic producer from foreign competition than it is about
giving your domestic producer an artificial boost into other countries’ markets by subsidizing
them, so they can take over market share abroad.
This method of creating international dominance is, of course, squarely in the arena of “unfair
advantage” (see argument number two), and is really an open invitation for other countries
to retaliate against you with restrictions of their own.
In this episode I went over many reasons why government might agree to protect the economic
interests of its domestic producers, even though they have comparative disadvantage
in production.
Next time, I'll show you in more detail how the government can protect domestic producers
by using tariffs, quotas, voluntary export restraints, or nontariff barriers to trade.
NEXT TIME: Types of trade restrictions TRANSCRIPT0 EPISODE 35: WHY DO COUNTRIES RESTRICT
TRADE?