Tuesday, April 3, 2007

I Answer Chris on Trade Wars

Reader Chris asks,

I am for free trade. I wish everyone was. However, I do wonder if unilateral 'disarmament' of trade barriers is akin to unilateral military disarmament?

In both cases, government's are spending money in a non-productive fashion (at least, not directly) to protect local production.

In both cases, it would be better if everyone disarmed, but it would also be better if each country was slightly better armed than everyone else.

thoughts? please tell me I'm wrong.



I debated about whether or not produce a set of graphs to deal with this question. In the end I decided, mostly in the interest of time, to try to do it verbally. Lets see how I do.

So, the basic Econ 101 answer to the question is that unilateral reduction in our trade barriers would help us.

Why?

When we erect a trade barrier the cost to our consumers is greater than the profit to our companies.

To see this suppose that we were to but a tariff on Chinese toys. Lets assume that currently the average Chinese toy is selling for $10. However, it costs an American company $15 to make the same toy. This means that the Chinese toy makers are completely driving the American toy makers out of business.

So, we decide to put up a tariff on Chinese toys equal to $7. Now a Chinese toy costs $17. With this new tariff the American companies can now safely charge $16 per toy and stay in business. They wind up covering their costs and pocketing $1 per toy in profit.

However, the American consumer winds up paying $16 per toy rather than $10 per toy. That means that each consumer is out $6 but the manufacturer only gets $1 in profit! It cost us $6 just to make $1! There is no way that's in our national interest.

Immediately people will say "But what about the jobs we gained. Its not just about corporate profits."

I'll put aside for a second a discussion of how the labor market actually works and just remind you of this - Each American consumer now has $6 less than before. That means that he or she has to buy $6 less of products. So even though there are more jobs in the American toy industry there are fewer jobs in other industries.

(Not to mention that in reality the $10 that we sent to China gets loaned back to us so that we can buy houses at a low interest rate. Thus, the tariff also hurts the housing industry)

That's the Econ 101 story.


Now as per usual GenEq (General Equilibrium) throws a big monkey wrench into that whole narrative. There are several reasons that I will just sketch.

1) We have to raise taxes to pay for government spending. When we put a tax on something the ultimate cost is split between consumers and producers. If we put a tax on goods from China then Chinese producers will bear part of the burden from the tax. That means that a tariff makes it cheaper for the government to raise money.

2) Tariffs cause redistribution. We may want redistribution. If we do not redistribute via tariffs we have to use some other method. That method will probably involve raising taxes to pay for some sort of subsidy. A tax-subsidy redistribution scheme causes dead weight loss twice, a tariff only once.

3) Tariffs can change the terms of trade. That is, suppose the United States is a big exporter of something. The US government can use a tariff to raise the price of that thing not just in the US but abroad as well. Then we will be exporting a more expensive product which better for us.

So for those reasons and few other more complex ones it is not always the case that trade barriers will make us worse off.

However, as far as I can tell it will almost always be in our interest to take advantage of countries that want to foolishly subsidize their exports. This is the case Greg was talking about this morning. In this case we just get cheap stuff and they pay for it. The only problem I see is if the foriegn subsidy caused serious redistribution issues that were very costly to fix.

20 comments:

Anonymous said...

Karl Smith,

You never seem to prove me wrong that you're the best damn blogger out there. Please prove me wrong some time!

Chris said...

Karl,

Thanks for the response. My question was less directed at the costs and benefits of free trade, and more how economic barriers differ from military barriers (which your point addresses, just from a different perspective.

Thankfully, your post caused me to reflect a bit more on my question and consequently my logic on the matter.

The following is the ramblings of an overly-tired college student with a viral infection... You've been warned.

To use a (relatively) simple example, dictators secure their country and their rule by arming themselves (among other things). Regardless of whether it is in the interest of the people to see the dictator ousted from an external or internal rival, the dictator will presume the 'good of the country' (which he assumes to protect) is connected to his own well-being.

The dictator who erects high tariffs to protect his agriculture cartel similarly argues he is guarding the sovereignty of the nation. Just as he does when he refuses to let in foreign capital.

Why? Because to some degree, he is guarding the sovereignty of the nation-state.

As the dictator's country comes to depend on imports (or exports or foreign capital), his country becomes increasingly vulnerable.

The noble dictator refuses for the same reason the United States refuses to disarm. He knows that the wholly self-sufficient organism is better equipped to survive. The organism who depends on potential enemies for sustenance lives precariously.

Now, I think the noble dictator is wrong to not disarm, whereas the United States is right.

Dictators can economically disarm because their lost decision-making power will be claimed by capitalists who have relatively benign aims (a general rule no doubt ... but these are just the broad strokes). Capitalists want to negotiate with people to exchange pay for goods. (The problem, you could say, is when the line between capitalists and politicians is blurred, and those with this economic power realize their political influence.)

Dictators won't do so if they believe the lost decision-making power will end up in the hands of enemies who will sabotage them.

Returning to military might, many countries have ceded military responsibility to the greater powers. Yet the United States won't disarm because there is no overarching global governance to secure it's well-being. It *IS* the global government.

There is very good reason to believe that if the United States disbanded its army and slashed military spending that the new balance of military power would hurt their interests. While the capitalists might be bad, the usurpers of military power have a far worse record.

Instead of capital flight, you have multiple World Wars. Those who cede economic influence can make the argument that the economic growth made possible outweighs the potential costs of economic influence being ceded to relatively harmless capitalists (with aims that often ally with that of the state). Those who cede military influence can make that argument only insofar as there is reason to believe the threat of the military-power usurpers is effectively neutralized.

Easy to say for Western Europe once the US was in their backyard. Not so easy for the US.

dWj said...

We benefit from lowering trade barriers, but if our counterparts in other countries are misguided mercantilists, it could be that we could use our own trade barriers as a chit to trade for them lowering theirs, which would be even better.

Chris said...

I have another question:

Why shouldn't developing economies protect their fledgling industries so that they might develop a comparative advantage over time? Why is the analogy of a mother sending her children to school to learn for 12 years not apt?

We don't demand that 5-year-olds compete in the labor market because we realize they have latent potential better tapped through protection from the market which will allow them to educate themselves (in theory).

Why not the same for developing countries?

(BESIDES the very real risk that other countries will similarly block the country's exports)

In both cases, some will not take advantage of the protection, but others will. There are tons of questions that would follow from this idea; such as, what technocrat is empowered and enlightened enough to ordain these protected industries? Doesn't this lend itself to protectionism? ... etc.

Still, I would rather hear a stronger argument about why developing economies shouldn't get the equivalent of 12-years of 'education' to develop their industries.

Chris said...

Whoops, at the end of my post, i meant to write: 'lend itself to corruption' -- not protectionism.

Call off the redundancy police.

Anonymous said...

I strongly refuse to believe that Karl can top himself if he answers this one...stay tuned, folks.

Steamboat Lion said...

If you need an example, look at Australia and NZ.

Both have comparative advantage in agriculture and still face significant barriers in key markets, namely the US Europe and Japan.

Both unilaterally dismantled significant tariff and non-tariff barriers over the past twenty years.

Yet both economies are far more productive and dynamic than they were 20 years ago, and more importantly the standard of living is much higher.

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