Free Trade and Protectionism

The integration of a country’s economy with the rest of the world has implications for nearly all its local businesses. This mass appeal is why business news dedicates substantial attention to global events. Moreover, the international relations with close trading partners (such as Europe for the UK) are analyzed in greater detail. Special emphasis is placed on government trade policies.

As far as an economist is concerned, international trade is almost always a win-win for all countries involved (this is a rare event since economists rarely agree with each other). The economic drivers favoring international trade are similar to the economic forces that compel people to trade with each other. At each scale, trade is driven by comparative advantage.

Since comparative advantage is a difficult concept, let’s first talk about absolute advantage. If Frank is better at crunching numbers than other people in his organization, he has an absolute advantage in bookkeeping. He would be the best candidate for bookkeeping or financial analyst work than other people in his organization. Similarly, he might be the best writer in his organization, too. Frank would also have an absolute advantage in creating marketing materials.

Suppose Mark also works at Frank’s organization. He is not as good at writing or at math as Frank is. Frank can produce three units of math per hour while Mark can produce only one unit of math per hour. Frank can produce four units of writing per hour while Mark can produce only three units of writing per hour. Frank has an absolute advantage over Mark in writing and in math.

Even though Mark falls short in both activities, trade allows Frank to benefit from working with Mark! This is because Frank’s work has an opportunity cost: every hour spent writing costs an hour of math that Frank puts off to do the writing. In Frank’s case, three units of math cost four units of writing, a cost of 1.33 units of writing per math. In Mark’s case, one unit of math costs three units of writing, a cost of three units of writing per math. In a sense, Frank has to give up less writing to do math than Mark does. Frank and Mark can both benefit by agreeing to trade between 1.33 and three units of writing per math, say two writing per math. Frank can provide Mark one unit of math and Mark will provide Frank with two units of writing in exchange. This deal benefits Frank because working to produce one unit of math costs him 1.33 units of writing production, and Frank just bought 2 units of writing instead. Mark also benefits since one unit of math only cost him 2 units of writing when one unit of math costs 3 units of writing when he does math himself.

Examples like this one can seem confusing because comparative advantage is a little trickier than absolute advantage. The conclusions we can draw from this are immense. First, Mark did not need to have an absolute advantage to benefit from trade, only a comparative advantage based on relative strengths. This means that you don’t need an absolute advantage to make trade worthwhile. Secondly, both parties benefited from the trade. Often the news media portrays a trade as having a winning side and a losing side. This is nonsense as long as the trade is conducted by willing, intelligent parties.

The importance of comparative advantage applies to entire countries. As was the case in our example, a country’s comparative advantage in producing specific goods is measured relatively. For instance, the UK may be more equipped than Bangladesh in producing cars as well as textiles, if measured in absolute terms. However, it makes sense for the UK to focus more on producing cars as Bangladesh is very poorly equipped to make cars (in fact they cannot) and trade some cars for clothes with Bangladesh. That way British people would get cheaper clothes than they would if the British businessmen were making textiles. This trade also provides people in Bangladesh with cars.

Trade is almost economic alchemy: before trade, buying cars in Bangladesh was impossible, and then trade made the impossible a reality. People in Bangladesh don’t need to develop the infrastructure and equipment to make the cars; they just have to trade. In fact, the most effective way for them to get more cars would be to focus on their textile industry rather than trying to incubate a domestic auto industry. They would then be able to trade textiles into cars. In a sense, they are sewing cars! Trade can transform those textiles from Bangladesh into cars more easily than the nation could make cars domestically.

Free trade has many detractors who would rather see trade barriers erected to limit or prevent foreign trade. Protectionism is an economic ideology that seeks to protect the interests of domestic businesses by setting up trade barriers and restrictive mechanisms such as duties, tariffs, quotas and taxes to limit the competition caused by market penetration from international participants. In contrast to protectionist policies, free trade policies minimize trade barriers among countries to facilitate the easy inflow and outflow of goods and services.

Protectionist actions are advantageous when a nation desires to build strength or competitive advantages in an identified industry; trade barriers will reduce foreign competition and stop foreign competitors from eating up the potential market. Another advantage of protectionism is that it also temporarily retains or creates domestic jobs. In the long run, however, protected industries can become weak and outdated because they are shielded from competitive pressure. The lack of competition slows innovation and the improvement of product quality. Eventually, consumers will be forced to settle with lower quality products for the same price that could have purchased a better quality product had more competition been allowed by the government.

The government regulates businesses by reserving the authority to decide key policies such as interest rates, tax rates, excise duties and trade restrictions. Moreover, the government may decide to tweak policies in favor of certain sectors of the economy. In an ideal world, the government would decide such policies by keeping in mind the larger interest of the whole population. However, such decisions are often driven more by political consideration and also by who can get his voice heard more than others. This is particularly true in cases of protection offered by a government for a particular sector.

For instance, it may make sense for consumers in the United Kingdom to buy sugar from other countries. It may be cheaper than growing and refining sugar in the UK. Thus, collectively the citizens of the UK would get cheap sugar (and in turn all products which use sugar as a raw material would be cheaper) if the UK trades sugar with some other good or service. However, domestic sugar producers in the UK would be opposed to this trade. They would lobby hard and cry against it. Now normal citizens would not pay much attention to this, as sugar is not really a big part of an average household’s budget. So  a smaller concentrated group (the sugar lobby) which is more directly affected by a trade may succeed in persuading the government and win protection for its sector.

The government has multiple tools at its disposal for offering protection to a sector. For example, it may extend protection to sugar farmers by levying a heavy tax on imported sugar that ultimately makes it more expensive for consumers to buy sugar grown in other countries.

Whether a protectionist policy will be good or bad for a selected business depends on whether or not developing a domestic industry is worth the cost society pays by foregoing better foreign products. Unfortunately, most discussions of global trade in the media ignore the benefits to consumers completely. Trade (global and otherwise) enriches consumers by providing them with more choices and by forcing producers to compete against each other.

So if free trade is such a good thing, why do so many individuals and institutions protest globalization? There are many legitimate reasons why people endorse protectionist policies, including the development of fledgling industries, enforcement of regulations and concerns about national security.

Sometimes a government will try to foster industries by creating trade barriers to give the industry an advantage in the domestic markets. If the industry is still building its competencies, it has higher chances of surviving if the government protects it against foreign competition. This is the economic version of protecting an ecosystem from non-native species so that native species will not go extinct.

Trade restrictions are also commonly justified to enforce regulatory or social norms on businesses. Domestic governments have laws to protect the environment and the welfare of their people. Many businesses have circumvented these laws by moving their operations to countries that are less regulated while selling products to their home country. If Canada erects pollution restrictions on its domestic factories, why should it allow countries without these restrictions to sell products within its borders? Many pollutants move across borders, so international businesses can literally pollute domestic markets and sell to domestic markets from foreign operations.

These considerations extend beyond environmental regulations. Many developed countries restrict how many hours children can work, require worker benefits, and charge domestic employees and employers heavy taxes. Foreign producers side step all these taxes and regulations and in doing so have an unfair advantage over domestic workers.

Governments may also restrict trade for national security. It is unwise to outsource the development of military technology to a foreign country, especially one that is not a devoted ally. Governments also advocate fostering essential domestic industries in case war prevents trade with foreign suppliers. International trade is also restricted as a form of punishment. Though this may harm the poor of foreign nations more than their leaders, it is an effective means of weakening a future adversary.

The greatest resistance to free trade comes from special interest groups inside a nation. Special interest considerations require that we think from the point of view of individual businesses, employees and politicians.

Even if both the United Kingdom and Bangladesh benefit from an arrangement which has the UK make cars to trade for clothes from Bangladesh, specific individuals and industries inside each country may be hurt. English textile workers may be laid off and English textile companies may go out of business in response to foreign competition. Instead of accepting this loss as a sacrifice for the greater good, many people will organize and lobby governments to prevent trade. Businesspeople running the textile firms realize they encourage the workers to protest about how Bangladeshi clothes are killing British jobs. As a result, the politicians may be persuaded to prohibit textile trade with Bangladesh.

Thus, what is good for a country as a whole (the people in the UK would get cheaper clothes) may not be good for a specific business and a specific group of people. In almost all of the cases, increased trade with the foreign trade partners would benefit UK economy. However, certain trades would harm specific groups and they may be able to lobby and force the government to stop some trading. Similar dynamics prevail in the countries of the European Union as well. It is always advisable for French and German economies to trade more with the UK; however, some interest groups may prevail over the government in those countries and force their hands.

Many people in developed countries believe that large corporations use free trade to steal jobs from domestic workers for a profit. They feel that this is amoral and that their fellow citizens are a victim of this process.

This argument is severely flawed. Firstly, jobs are typically transferred to another location, not destroyed. They often go to places where workers have a lower standard of living and thus benefit more from work than employees in developed nations who have more opportunities.

Secondly, a corporation is a legal entity with many stakeholders. Some of the owners of large, publicly traded companies are pensioners and private investors. Is it wrong for these investors to see a return on their investment so that they can fund retirement and other financial goals?

Sadly, resistance to outsourcing exposes xenophobia and a bias toward people who are closer to you over people who are farther away. Educated people in the 21st century should respect other people even if they are different or don’t live nearby.