1. The case for international trade
The principle that modern economies are based on exchange is
accepted by both economists and the public, and it is generally
agreed that trade within a country should not be restricted among
cities, provinces, and states. But many people have a different
opinion about trade among countries. What is it about a national
boundary that makes it desirable to have trade barriers, aside from
political reasons such as national defense? National boundaries
rarely map out an area that is self-sufficient. Trade allows a
nation to concentrate on producing that combination of goods for
which it is most efficient.
"Gains from trade" are the additional output that takes place
when parties exchange goods. There are two sources of gains from
trade: one is that, among nations, differing natural resource
endowments will lead to advantages in the production of certain
kinds of commodities. The second source of gain stems from the
decreasing cost of production that results from specialization.
Resource endowments include land (including agricultural land,
rainfall, minerals and oil, water, climate, and ports), labor
(including skills and the wage level), and capital goods
(including technology, knowledge, and historical capital such as
architecture and culture).
The most obvious type of gain is an absolute advantage, which
is the ability to produce a greater quantity of some product than
another country, using the same inputs. Imagine that with one unit
of resources, the U.S. can produce 10 units of apples and 6 units
of shoes, and that with the same resources, the European Community
can produce 5 units of apples and 10 units of shoes. The US then
has an absolute advantage in apples and the EC has an absolute
advantage in the production of shoes.
The more resources are transferred from shoes to apple
production in the US and vice versa in the EC, the greater will be
the overall and most efficient production of both goods.
However, will trade still occur if the US has an absolute
advantage over the EC in the production of both apples and shoes?
David Ricardo in 1817 resolved the question with the theory of
comparative advantage. Suppose a lawyer can earn $100 per hour
doing legal work, and can type 100 words per minute. Suppose
secretaries can be hired for $10 per hour, but they can only type
50 words per minute. The lawyer has an absolute advantage in
typing. Should be hire the secretary anyway? Yes, because the
secretary has a relative advantage in typing. If he does his own
typing, he saves $20 per hour (from two secretaries), but loses
$100 in legal work, for a net loss of $80. He is better off hiring
two secretaries to do what he could do in an hour. The same
principle applies to trade between countries.
There can be gains from specialization and trade even when
there is no absolute advantage. By concentrating in what it is
best at, a country will be better off exporting that item and
importing what it is relatively less efficient at. Gains can be
derived from the process of specialization itself. An economy
which specializes in the production of certain goods will develop
economies of scale - greater efficiency with greater output, as
with automobile manufacturing. Secondly, an economy will gain
skill in efficiency, quality, and variety. Comparative advantage
is not a given, but can be created, and lost. The theory of
comparative advantage is dynamic, as both natural and created
advantages change over time.
Gains from specialization depend on the "terms of trade." This
concept measures the amount of imported goods that can be obtained
per unit of exported goods. A rise in the price of imported goods,
while that of exports remains unchanged, reduces the terms of
trade. The dramatic increase in oil prices in the 1970's led to a
decrease in the terms of trade for oil-importing countries. In the
last few decades, some developing countries have seen the prices
for their export commodities steadily decline. Markets adjust to
changing terms of trade by importing less of the item increasing in
price (such as conserving oil and finding substitutes) and
switching from exports that lose relative value to those, such as
manufactures, which are gaining in relative value.
2. Free trade and trade barriers
Free trade is the exchange of goods without any trade barriers
such as quotas and tariffs. Trade barriers consist in interference
by the government to "protect" domestic industries. This trade
limitation is commonly referred to as a protectionist policy.
Protectionism is also called "mercantilism," from the mercantile
economic system that European countries pursued from the 1500s to
the 1700s, when trade was tightly regulated. Adam Smith, in The
Wealth of Nations, showed how trade limitation reduces wealth,
since if all countries restrict trade, the result is less wealth in
each country. Yet, most governments impose restrictions on trade
in an effort to "protect" domestic industries. There are political
reasons for mercantilism - some industries influence the government
to favor their special interest at the expense of the public well
The two basic types of trade limitation are tariffs and
quotas. A tariff or import duty is a tax on imported goods.
Tariffs raise the price of the good, reducing the quantity demanded
and thus reducing the amount imported and making domestic
production more profitable. An import quota is a limitation on the
quantity of an import, which enables domestic producers to raise
their prices. Either way, consumers are worse off, due to the
higher prices and lower quantities of the goods. The ultimate
quota is zero - an embargo or prohibition on the import and export
of goods. For example, the United States has had an embargo on
trade with Cuba. Some countries also impose a tax on exports,
which by making exports more expensive reduces their production.
Despite the negative effects on the economy, many less-developed
countries impose taxes on foreign trade because such taxes are
easier to collect than taxes on production, and such taxes enable
them to avoid taxing land, which may be opposed by powerful elites.
Another option available to the government wishing to restrict
imports, is to reduce the demand for the imported good. One way to
do this is to legally require a percentage of domestic production
in some goods. The demand for foreign goods can also be restricted
by limiting the use of foreign exchange and also by manipulating
currency exchange rates, making the domestic currency less valuable
relative to foreign money, increasing the price of imports,
reducing the quantity demanded.
All such restrictions on free trade damage the general
welfare, at least in the short run. Those advocating trade
barriers argue that these encourage economic development in the
long run by protecting "infant industries" until they can mature
and obtain more experience and a lower cost. But another way to
protect such industries is with subsidies, which leave fewer
distortions in the relative price structure and make the cost more
explicit. More fundamentally, there is no guarantee that the
protected industry will become more efficient; just the opposite
can occur, as the firms rely on artificially high prices to remain
inefficient. Also, trade limitation subjects the process to
political influences. It is also not clear why the initial time
when the industry is getting started should not be paid for by the
investors rather than the taxpayers. The infant-industry argument
is therefore weak at best and subject to the problem of the lack of
knowledge as to whether it will succeed and to manipulation by
special interests. Once an industry is given a privileged
position, it becomes a special interest that will perpetually seek
to preserve its privilege.
Many trade limitations, involving both subsidies and quotas,
do not involve infant industries at all, but are an attempt to
preserve the economic condition of an industry such as agriculture
which cannot be sustained at current market prices. For example,
the Common Agricultural Policy of the European Common Market costs
its taxpayers 23 billion British pounds per year. In the European
Sugar Policy, the European Community subsidizes the overproduction
of beet sugar in inefficient places such as Great Britain and
Portugal. Indeed, every country in the EC is producing sugar,
despite of the fact that France and Italy alone could adequately
supply all of Europe's needs. The result of the EC Sugar Policy is
to produce three million more tones of beet a year than Europeans
can consume. The damage caused by this policy goes beyond the
waste of taxpayers' money. The surplus production is dumped on the
world market, reducing the price of cane sugar exported by
developing countries (Rowling, 1987, p. 70).
The United States also restricts sugar imports with quotas as well as price support, further depressing world market prices.
In an attempt to protect farmers from world prices, the US
Government sets target prices for crops and pays the difference.
The US government also uses quotas. Peanuts, for example, have
both a quota on imports and price supports, and milk, butter, and
cheese have been protected with price supports.
Trade limitations are also imposed to protect labor from
lower-wage competition abroad. Manufacturing enterprise has been
shifting labor-intensive production such as textiles to economies
with lower labor costs, and workers in the domestic industries then
lobby for trade barriers on the lower-priced imports. In the
interventionist markets of today, displaced workers often have a
difficult time finding other work of the same wage scale. In a
free market, prosperity and the absence of a tax wedge on wages
would provide a continuous demand for skilled labor, so that those
who become trained in new fields or are willing to relocate to
growing areas would find ready employment.
Trade barriers are defended as a superficial treatment of
effects, rather than as the fundamental remedy of the cause, of low
wages and unemployment. As Henry George (1886, p. 9) stated in his
book Protection or Free Trade, "the advocates of protection ...
extol the virtues of protection as furnishing employment, without
asking how it comes that any one should need to be furnished with
employment; they assert that protection maintains the rate of
wages, without explaining what determines the rate of wages."
Advocates of trade limitation inconsistently advocate tariffs
between countries but not within countries, and they do not
advocate other barriers which would have the same effect. If trade
barriers are beneficial, why not others? As George (1886, p. 35)
put it, "Who would think of recommending a site for a proposed city
or a new colony because it was very difficult to get at? Yet, if
the protective theory be true, this would really be an advantage."
Piracy would also be welcomed as increasing the cost of imports.
Also, we regard canals, railroads, and better ships as beneficial,
yet how can tariffs then be beneficial? Improved transportation
reduces the cost of bringing in foreign goods, while tariffs
increase the cost. "We maintain a tariff with the avowed purpose
of keeping out the products of cheap foreign labor; yet machines
are daily invented that produce goods cheaper than the cheapest
foreign labor" (p. 36).
George also asks (p. 37), "Is there not, in the first place,
an obvious absurdity in taking the nation or country as the
protective unit and saying that each should have a protective
tariff!" National boundaries have been changing constantly.
"Political changes in no wise alter soil, climate, or industrial
needs" (p. 39). If Virginia goods must be protected from those of
France, why not also protect them from the imports of New York or
California? If Virginia was a separate country, there would likely
be such tariffs. Would it be for political or economic reasons?
Aside from national defense, there is no economic difference
between domestic exchange and international exchange.
To counter trade barriers and promote international trade,
especially in manufactured goods, the General Agreement on Tariffs
and Trade (GATT) was signed in 1947. Since GATT was founded,
significant reductions in tariffs have been achieved by the member
states. Many developing countries which maintained protectionist
policies are now liberalizing their trading policies. Regional
trading blocks such as the European Community and the North
American Free Trade Agreement (NAFTA) are reducing trade barriers
in continental regions.
3. The impact of trade on land
A major problem with international trade is the unequal
environmental policy among countries. For example, as US companies
relocate south of the border in search of cheap labor, some
companies have dumped toxic waste into the Rio Grande, causing
serious health and water-supply problems in the area. But such
pollution is not part of "free" trade. A truly free market
consists of voluntary exchanges, and dumping pollutants is not
voluntary to the victims. Polluting is an act of force unless it
is agreed to. The second best solution is compensation for the
damage cause. Hence, in a free market, polluters must be charged
for the social costs. As noted in Chapter 13, this charge is a
type of rent for the use of land (including water and air as
economic land) as a dump.
The problem in free trade is then to equalize such pollution
charges, otherwise some countries will have an unjust advantage.
Those with lower pollution charges will have lower production
costs, but these are really environmental costs being imposed on
others. Free trade thus requires an international agreement on
common charges for environmental destruction.
A comprehensive agreement would include fees, fines, and other
charges on any use and abuse of natural resources, including
pollution, the destruction of wildlife, deforestation, and soil
The other impact that trade has on land is the increase in
land rent and land value that accompanies an increase in
productivity and investment. A substantial amount of the benefits
will go to landowners. The collection of this rent by local and
national communities will enable the population as a whole to
benefit equally from this increase in prosperity. We can look to
Great Britain for an illustration. During the days of the British
Empire, the western UK ports - Bristol, Liverpool and Glasgow -
were the most prosperous. After the decision to align Britain more
closely with European countries, British ports on the east coast
became the new centers of prosperity, with a subsequent increase in
land values. The land owners of the east received a windfall from
the activity of the ports. The collection of the land rent by the
UK would equalize this benefit rather than letting it fall to those
who did nothing to cause it.
The issue of international trade thus has an intimate connection with public revenue and environmental policy. Truly free trade requires the community collection of rent, including pollution charges, just as it requires the removal of taxes and restrictions on trade.