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Sunday, March 25, 2012

19. Free Trade vs. Protectionism

The Concise Guide To Economics

by Jim Cox

19. 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?


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.

Cheap Foreign Labor

This argument claims that American workers should not have to compete unfairly with low paid foreigners.  (Everyone comes up with some reason to except themselves from free competition; low paid foreign workers claim it is unfair for them to have to compete with high skilled American workers!)   As do all protectionist arguments this one violates the principle of not producing at home that which can be obtained more cheaply abroad. Besides this self-interest argument against protectionism, it is anything but humane to call for sacrificing the living conditions of already poor foreigners to that of relatively very wealthy American workers.

Concise Guide to Economics, The

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