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Free Trade versus Protectionism

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A specter is haunting the economies of the world. It is the specter of protectionism. In one country after the other, cries are heard that international trade, rather than bringing mutual prosperity, imposes economic hardship on some nations so that others may gain. Trading practices among nations are declared to be “unfair.” Jobs are supposedly lost through “cheap” imports flooding domestic markets. Balance of trade deficits threaten the financial stability of not only third-world countries, but the United States as well.

And the solutions proposed are the same everywhere: demands are made for the imposition or stiffening of trade restrictions – the raising of barriers in the path of trade among nations. It is claimed that limitations on amounts of foreign supplies entering the domestic market, through either tariffs that make foreign goods more costly or quotas that prohibit the quantities which may be imported, will increase the market share of domestic companies as well as enhance employment opportunities at home.

The reasoning seems straightforward and sensible. However, it suffers from one handicap: It is dead wrong! When implemented, protectionist policies bring economic harm, as well as lower standards of living, for the people of every nation choosing to follow this path.

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.

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    Richard M. Ebeling is a professor of economics at Northwood University. He was formerly president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).