A lesson in trade theory

“Every economic answer is a political question.”

Here then is a question for all you experts on international trade, taken directly from my Free Market Economics [pp. 248-249]. Picture two countries, A and C.

Suppose in Country A, in one hour it can produce either one car or 1000 shirts. [It’s also the same answer if Country A can produce ten cars and 10,000 shirts per hour!]

Meanwhile in Country C, in two hours it can produce either one car or 500 shirts.

According to the economic theory of comparative advantage, how many cars will Country A produce? OK, once you’ve worked that out, now tell me if you get the same answer using common sense. As chrisl said, “economic theory is all right in theory”. Personally, I’m not even sure of that, but you get the idea.

So here’s the thing. It is entirely possible that the US is tired of carrying most of the burden for the defence of the West and would like a bit of sharing the burden. It might also find some respite for itself in strengthening those parts of its economy which are more closely associated with its defence industries. And it might even wish for some kind of gratitude from others, supposedly on the same side, in trying to assist the US in resurrecting its strength. And then there are the straightforward economic issues, which are not the same as the political. So let us go to these.

And of course the issue economically is comparative advantage, and not pure let the most efficient producer produce each product. With comparative advantage, it is not always the most efficient low-cost producers who produce. If you don’t even understand that, you should keep right out of this debate.

Why encourage free trade:

  • competition is what drives improvement and growth – without competition most businesses would just coast along to the fullest extent they could
  • innovation is driven by competition – the way to take on an established business is to find a better way to do something
  • all other things being equal, free trade is best

Why “free trade” is not working for the US:

  • cheating is rife – try to sell an American car in Japan – not possible for all kinds of products in all kinds of countries
  • many countries subsidise exports while imposing non-tariff barriers to trade on imports along with tariffs themselves
  • currency manipulation – artificially holding exchange rate lower to discourage imports and encourage exports is not unknown
  • $US is world reserve currency it is unable to adjust to repair a balance of payments deficit
  • there are many forms of approved trade restrictions everywhere you look – the EU for example – such as:

Trading blocs

A regional trading bloc is a group of countries within a geographical region that protect themselves from imports from non-members. Trading blocs are a form of economic integration, and increasingly shape the pattern of world trade. There are several types of trading bloc:

Preferential Trade Area

Preferential Trade Areas (PTAs) exist when countries within a geographical region agree to reduce or eliminate tariff barriers on selected goods imported from other members of the area. This is often the first small step towards the creation of a trading bloc.

Free Trade Area

Free Trade Areas (FTAs) are created when two or more countries in a region agree to reduce or eliminate barriers to trade on all goods coming from other members.

Customs Union

A customs union involves the removal of tariff barriers between members, plus the acceptance of a common (unified) external tariff against non-members. This means that members may negotiate as a single bloc with 3rd parties, such as with other trading blocs, or with the WTO.

World Trade Organisation

There are then the WTO rules of trade engagement which are not designed to create a world where free trade is on the only answer. The rules were devised when the US economy was a lot more robust than it now is, and when the US was both willing and able to make sacrifices of all kinds to help others withstand the spread of communism. None of this is applicable today. The US is therefore no longer willing to watch others cheat their way into a stronger trade position, at the cost of its own national security, economic strength and domestic employment. Here is part of what the WTO is up to.

WTO Rules

1. Most-favoured-nation (MFN): treating other people equally Under the WTO agreements, countries cannot normally discriminate between their trading partners. Grant someone a special favour (such as a lower customs duty rate for one of their products) and you have to do the same for all other WTO members.

2. National treatment: Treating foreigners and locals equally Imported and locally-produced goods should be treated equally — at least after the foreign goods have entered the market. The same should apply to foreign and domestic services, and to foreign and local trademarks, copyrights and patents.

3. Developing countries have transition periods to adjust to the more unfamiliar and, perhaps, difficult WTO provisions — particularly so for the poorest, “least-developed” countries – so these basket case economies are allowed to whittle away at the economic strength of the developed world.

Meanwhile, economic ministers around the world increase unproductive public spending every chance they get, add new regulations on top of old, and increase business taxes at every turn, and then job on their chairs screaming, “Eek, a tariff!’

The quote at the top, by the way, is from Joan Robinson, who has quite a lot to say about free trade that ought to be read by the economic illiterates who populate the world, who are now found speaking on behalf of the status quo, as harmful as the status quo is to most of the lower half of the income distribution. Robinson was not just a Keynesian but also a big supporter of Mao, so I’d be very careful, but the above quote seems as accurate as anything else you are likely to hear about economics.

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