Huwebes, Marso 15, 2012

Protectionism Versus Free Trade

“It is a very common clever device that when anyone has attained the summit of greatness, he kicks away the ladder by which he has climbed up, in order to deprive others of the means of climbing up after him.”

        Protectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow (according to proponents) "fair competition" between imports and goods and services produced domestically.
     This policy contrasts with free trade, where government barriers to trade are kept to a minimum. In recent years, it has become closely aligned with anti-globalization. The term is mostly used in the context of economics, where protectionism refers to policies or doctrines which protect businesses and workers within a country by restricting or regulating trade with foreign nations.
          Historically, protectionism was associated with economic theories such as mercantilism (that believed that it is beneficial to maintain a positive trade balance), and import substitution.      During that time, Adam Smith famously warned against the "interested sophistry" of industry, seeking to gain advantage at the cost of the consumers.
           Over the course of history, the majority of economists promoted protectionism. However, in the contemporary era, most mainstream economists state that protectionism is harmful in that its costs outweigh the benefits and that it impedes economic growth. Almost all present day economic schools solely promoted Free trade and have assumed a dogmatically anti-protectionist opinion. Indeed, economics Nobel prize winner and trade theorist Paul Krugmanonce infamously stated, "If there were an Economist's Creed, it would surely contain the affirmations 'I understand the Principle of Comparative Advantage' and 'I advocate Free Trade'.”

         Free trade is a policy by which a government does not discriminate against imports or interfere with exports by applying tariffs (to imports) or subsidies (to exports). According to the law of comparative advantage the policy permits trading partners mutual gains from trade of goods and services.
Under a free trade policy, prices emerge from supply and demand, and are the sole determinant of resource allocation. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from those which would emerge under deregulation. These governed prices are the result of government intervention in the market through price adjustments or supply restrictions, including protectionist policies. Such government interventions can increase as well as decrease the cost of goods and services to both consumers and producers.
Since the mid-20th century, nations have increasingly reduced tariff barriers and currency restrictions on international trade. Other barriers, however, that may be equally effective in hindering trade include import quotas, taxes, and diverse means of subsidizing domestic industries. Interventions include subsidies, taxes and tariffs, non-tariff barriers, such as regulatory legislation and import quotas, and even inter-government managed trade agreements such as the North American Free Trade Agreement(NAFTA) and Central America Free Trade Agreement (CAFTA) (contrary to their formal titles) and any governmental market intervention resulting in artificial prices.
If the protectionist argument is correct - that buying Japanese goods, for example, is harmful to American industry and jobs as a whole - then the same logic would have to imply that importing New Mexico goods is harmful to Texas industry and jobs; and that buying Fort Worth goods is harmful to Dallas industry and jobs. Why does the Japanese-U.S. argument seem plausible, while the Fort Worth-Dallas argument appears suspect? Because people still suffer from the tribal notion that suggests that the accident of a political boundary across the face of a map must imply antagonism between the human beings who live on different sides of that boundary.
International trade is nothing more than an extension of the social division of labor across national borders. And the same advantages that arise from a division of labor between members of the same nation apply among members of different nations. It enables a specialization of skills and abilities, with each member of the world economic community tending to specialize in that line of production in which he has a comparative advantage (a relative superiority) in relation to his trading neighbors.
Through such a division of tasks and activities, the wealth and prosperity of every nation is increased, as compared to a situation in which individuals or nations are required to obtain what they desire through their own efforts, in economic isolation from their fellow men.
But what of the particular charges presently leveled against our foreign trading partners? What about the detrimental effects which supposedly result from the trading policies of other nations?

Let us examine some of these charges:
1. Unfair Trading Practices. A number of nations have been accused of unfairly subsidizing the export of goods to America, i.e., at prices which are below their "actual" cost of production.
The world is going through a dramatic technological and economic revolution, with many underdeveloped nations finally entering the industrialized era. Their lower prices often merely reflect their lower costs of production, as they shift into positions in the international division of labor which reflect those areas where their relative economic efficiencies are greatest. As these nations sell more in the United States, they earn the purchasing power to buy more from America. American exports, therefore, increase because the only way for foreigners to buy more from Americans is for Americans to sell more to foreigners.
To the extent that foreign governments do subsidize some products sold in the U.S., this means that Americans are able to buy them below what would have otherwise been the market price. In other words, we are given a bargain, a bargain that saves us resources that would have been devoted to the making of more products to pay for what otherwise would have been higher-priced imports. And these resources are now available to make other things that we would not have been able to produce without this bargain. It is the citizens of those other nations who should be outraged since they, not us, have to foot the tax bill to pay for the subsidies.
2. Foreign Products Cause Loss of Jobs. The charge is made that the sale of foreign goods in America "steals" markets away from American companies, with a resulting loss of jobs in America.
This argument ignores the fact that these foreign goods must be paid for. It is true that jobs in those sectors of the economy which directly compete against certain foreign products may be lost. But other jobs are created in those industries which manufacture goods which foreigners are interested in purchasing from Americans. The sale of foreign goods in America may change the locale and types of employments in the U.S., but it need not result, over time, in any net loss of jobs.
Furthermore, with free trade, Americans end up spending less of their income on certain products because they are bought more cheaply from foreign suppliers. This leaves them with extra dollars with which they are able to increase their demand for other goods on the market. The net effect, therefore, is to stimulate even more employment opportunities than previously existed.
3. The Balance of Trade Deficit and Foreign Investment. The leading issue during the last several years has been the charge that America buys more abroad than it sells, resulting in a trade deficit that threatens the economic stability of the United States.

It is true that in terms of tangible or visible goods, the U.S. has been buying more than it has sold. But this overlooks the overall trade "balance sheet." Instead of buying American commodities with the dollars they have earned, foreign earners of dollars have returned some of them to America in the form of savings in the credit markets, or as direct investment in U.S. industry. The overall balance of payments between the United States and the rest of the world has balanced.
When this is pointed out, the concern expressed is that foreigners are "buying up America." "They" will control "us." Actually, however, when the foreign investment is "indirect," i.e., loaned to Americans through the banking system, this merely increases the pool of savings in the United States; and this pool of savings is available to domestic businessmen who desire to expand or improve their plant and equipment. If wisely used, the money borrowed will be paid back, with interest. And, in a few years, the productive capital in America will be greater and more efficient. Industry will still be in "our" hands.
But what if the investment is direct? Won't foreigners "control" America by buying out existing companies or starting up new businesses which successfully compete against American-owned firms? Again, this reflects the collectivist notions of past ages, notions which think of those who belong to other nations - "tribes" - as inherently dangerous enemies.
But those of other nations who invest in America are actually "our" captives - if one wishes to use this form of reasoning. They have invested their savings in America because it has offered the most attractive economic and political environment. Their own fortunes and futures are linked to continuing American prosperity; and they must manage their investments in judicious, market-oriented directions if they are to generate the profits for which they hope.
But what if "they" pulled out? Would that not hurt "us" by disrupting "our" economy? In such a case, the physical plant and equipment remain in America. To 'pull out,' they would have to find willing buyers. And to do that, they would have to offer attractive prices to prospective buyers. And they would only want to sell out if either the political or economic climate in the U.S. became less attractive as compared to other countries. But are these not the same incentives and motives which guide Americans who invest and save in New York rather than California, or in the U.S. rather than some other country?
While there will always be necessary adjustments to new and changing circumstances, free trade between nations ultimately benefits all who participate. Protectionism can only lead us down a road of impoverishment and international commercial tensions. To paraphrase the great 18th-century, free-market thinker, David Hume, when he criticized the protectionists of his time: Not only as a man, but as an American, I pray for the flourishing commerce of Germany, France, England and even Japan. Why? Because America's prosperity and economic future are dependent upon the economic prosperity of all of those with whom it trades in the international division of labor.

They claim that developing country producers need to be exposed to maximum competition, so that they have maximum incentive to raise productivity. The earlier the exposure, the argument goes, the better it is for economic development.
However, just as children need to be nurtured before they can compete in high-productivity jobs, industries in developing countries should be sheltered from superior foreign producers before they "grow up". They need to be given protection, subsidies, and other help while they master advanced technologies and build effective organisations.

This argument is known as the "infant industry" argument. What is little known is that it was first theorised by none other than the first finance minister (treasury secretary) of the United States - Alexander Hamilton, whose portrait adorns the $10 bill.
Initially few Americans were convinced by Hamilton's argument. After all, Adam Smith, the father of economics, had already advised Americans against artificially developing manufacturing industries. However, over time people saw sense in Hamilton's argument, and the US shifted to protectionism after the Anglo-American War of 1812. By the 1830s, its industrial tariff rate, at 40-50 per cent, was the highest in the world, and remained so until the Second World War.

The US may have invented the theory of infant industry protection, but the practice had existed long before. The first big success story was, surprisingly, Britain - the supposed birthplace of free trade. In fact, Hamilton's programme was in many ways a copy of Robert Walpole's enormously successful 1721 industrial development programme, based on high (among world's highest) tariffs and subsidies, which had propelled Britain into its economic supremacy.

Britain and the US may have been the most ardent - and most successful - users of tariffs, but most of today's rich countries deployed tariff protection for extended periods in order to promote their infant industries. Many of them also actively used government subsidies and public enterprises to promote new industries. Japan and many European countries have given numerous subsidies to strategic industries. The US has publicly financed the highest share of research and development in the world. Singapore, despite its free-market image, has one of the largest public enterprise sectors in the world, producing around 30 per cent of the national income. Public enterprises were also crucial in France, Finland, Austria, Norway, and Taiwan.

When they needed to protect their nascent producers, most of today's rich countries restricted foreign investment. In the 19th century, the US strictly regulated foreign investment in banking, shipping, mining, and logging. Japan and Korea severely restricted foreign investment in manufacturing. Between the 1930s and the 1980s, Finland officially classified all firms with more than 20 per cent foreign ownership as "dangerous enterprises".

The first problem with free trade is that conventional arguments for it are about GDP. But GDP is not identical with material well-being. Whenever someone breaks a window or gets a divorce, GDP goes up. So even if free trade economics were 100% valid (it isn't), free trade would still not necessarily be best.

The second problem is externalities, or when economic value is created or destroyed without a price tag. Negative externalities like environmental damage are well known. Less well-appreciated in the U.S. are positive externalities, like the way some industries open up paths of growth for the entire economy. Free trade can wipe out these industries because it ignores this hidden value.

The third problem is the assumption trade is sustainable. A nation exporting non-renewable resources may discover that its best move (in the short run) is to export until it runs out. The flip side is overconsumption, in which a nation (like the present-day U.S.) borrows from abroad and sells off assets in order to finance a short-term binge of imports that lowers its long-term living standard. Free trade economics defines both these problems out of existence by conceiving economic efficiency as merely the optimal satisfaction of consumer preferences, so if consumers want a short-term binge, then free trade is "efficient."

The fourth problem is the assumption that free trade does not increase income inequality. If it does, free trade may benefit the economy as a whole yet harm most people in it. Free trade tends to raise return to the abundant input to production (in America, capital) and lower returns to the scarce input (in America, labor), so it benefits capital at labor's expense.

The fifth problem is the assumption, in the all-important theory of comparative advantage, that factors of production (especially capital) are not mobile between nations. This theory says free trade will reshuffle a nation's factors of production to their most productive uses. But if factors of production are internationally mobile, and their most-productive use is in another country, then free trade will cause them to migrate there--which is not necessarily best for the nation they depart.

The sixth problem is that this theory assumes factors of production are mobile within nations. Unemployed autoworkers become aircraft workers, and abandoned automobile plants turn into aircraft factories.

The seventh problem is that this theory assumes the economy is always operating at full output, or at least that trade has no effect on its output level.

The eighth problem is that this theory assumes short-term efficiency is the origin of long-term growth. But economic growth is about turning from Burkina Faso into South Korea, not about being the most-efficient possible Burkina Faso forever. History has shown that the short-term inefficiencies of a prudent tariff are more than compensated for by the long-term spur to industry growth it can provide, largely because growth has more to do with the industry externalities mentioned above than short-term efficiency per se.

The ninth problem is that this theory merely guarantees (if true) there will be gains from trade. It does not guarantee that changes induced by free trade, like rising productivity abroad, will cause these gains to grow rather than shrink. So free trade can strengthen our rivals.

The tenth problem is that, in the presence of scale economies, the perfectly-competitive international markets assumed by the theory of comparative advantage do not exist. Instead, outsize returns accrue to nations that host global oligopoly industries. And free trade will not necessarily assign any given nation these industries.

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