Inflationomics

International Trade

Take a look at the labels around you.  The labels on the products you use every day. You might discover that your phone is from Korea or China, your clothes were made in Indonesia or Pakistan, and your bananas were grown in Colombia. What if everything that didn’t have a “made in the USA” stamp suddenly doubled in price?

If you’re rich, you might find your standard of living lower than it used to be, and if you’re already struggling, you might be unable to afford even basic things, like toothpaste (made in China) or garbage bags (made in Canada). Nobody is happy when prices go up.

Foreign-manufactured products aren’t always cheaper, but they’re cheaper often enough to make a difference. Why are they cheaper? Because some countries have natural resources that other countries don’t have. Some countries have cheaper labor (because of many years of socialism or communism, for example) than others.  Some countries have better bank secrecy laws, thus attracting more capital, than others.  This gives them an advantage over other countries, which leads us to the economic laws of comparative and absolute advantage.

Put simply, the law of absolute advantage says that instead of having a carpenter and a metal worker each spend half their time working metal and wood for themselves, the carpenter should work primarily with wood, and the metal worker should work primarily with metal. When they trade with each other at the end, more wood products AND more metal products will exist in total, because both workers are playing to their strengths (for which they have an absolute or complete advantage).  Those products will be higher quality, too.

Comparative advantage is a little more complicated. Say we have someone who is both a master carpenter and a master metal worker, and he or she takes an apprentice who shows more talent for metalworking than for carpentry. Even though the master can do both kinds of work more efficiently than the apprentice, the master should concentrate only on carpentry and let the apprentice do only metalworking, because that plays to both their strengths. If the master works wood and the apprentice works metal, more wood and metal products will be produced than if each of them split their time half-and-half between wood and metal.

On a macro scale, absolute and comparative advantages are powerful forces. You could just as easily replace the carpenter and metal worker above with countries of phone and clothing manufacturers, or the master and apprentice with a more economically developed country and a less economically developed country. So long as countries are willing to specialize in products they’re good at making and trade with other countries for the rest, everyone can have more products.

If each country focuses on what they make best, and they all trade, there will be more goods to be distributed and everyone gets more for less

The problem is: absolute and comparative advantages are not the only forces in the world. Embargoes, tariffs, subsidies, trade agreements, double-taxation agreements, licensing requirements, labeling requirements, sanctions, import and export restrictions, protections on “strategic industries,” wars, and other populist political interventions stand between “free trade” in theory and “free trade” in practice.  The slower and harder that the bureaucracy makes it trade for trade to occur, the more expensive it gets to exchange goods, and the less stuff everyone gets. The “freer” trade is, the better comparative advantage works (if you’re curious about just how much trade the U.S. does, take a look at the reports here).

One of the most obvious restrictions on trade, and the thing most likely to double the price of everything without a “made in the USA” stamp, is tariffs. For a historical example, look at the Smoot-Hawley Tariff Act, passed in 1930 during the Great Depression. It raised some tariffs as high as 59.1% but left 63% of imports untaxed, destroying some industries while leaving others untouched—at least directly. When offended trade partners raised their own tariffs in response, US agricultural exports were wiped out and mining exports fell off drastically, and banks that had loans in those industries collapsed. The failed loans caused a chain reaction, dragging other banks and industries off a cliff as well.  The Great Depression was made drastically “greater” and longer as a result.

The moral of the story is, if we interfere with free trade, we may be more self-reliant, but we will all be poorer for it.  Higher prices and fewer goods will be the new normal.

Roland F. Sennholz

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