With Donald Trump getting all aggressive about tariffs, I wanted to revisit an older post (from 2013). The thing is: most economists agree that free trade is generally better for an economy than not, and it’s heretical to be Trumpian (or BernieSandersian) about it. But I have some sympathy with the protectionist argument. Sort of.

How Free Trade is meant to work

The principle behind free trade is fairly simple: we are collectively better off when we trade freely.

An example: in Zimbabwe, it is expensive to produce sugar. Costs of labour are high, economies of scale are not what they were, and all expenses are denominated in US dollars whilst the regional competition are all operating in depreciating currencies. According to this article, in 2013 Zimbabwean sugar was selling at a 60% premium to the landed price of sugar from the sub-Saharan region.

If Zimbabwe were to import in sugar (in exchange for something else – say, diamonds), then:

  1. Zimbabweans in general will be able to buy more sugar; and
  2. The regional sugar producers will make more sales.

Sure, the Zimbabwean sugar industry would shut down (it can’t compete), but it was an inefficient use of resources anyway (compared to the rest of the region). Besides, all those sugar industry resources can now be used to extract more diamonds.

Everyone wins.

In principle.

Societal Losses from tariffs

And then the argument says that only wicked, populist and interfering governments like to stop free trade, because they just don’t have the moral fortitude to stay the course and let the sugar farmers become diamond miners.

And they lack the moral fortitude because, in the interim, there are going to be some angry unemployed folks at the sugar industry – and those self-interested elected officials will lose votes (and funding).

So they impose tariffs and trade quotas in order to protect local industry. And then you get the uber free market economists presenting this sort of graph*:
*the graph is wikipedia’s. Find the original here.

effect of tariff

So you see, there’s a graph with pink regions that clearly demonstrates that society is losing when tariffs (or any other protectionist measure) prevent free trade from happening.

Those naughty left-wingers with their populism.


The Trouble With Free Trade

There are some common criticisms of free trade.

Problem 1: The playing field is not a level one.

I realise that this sounds like a trite observation: but it’s an important one.

The world is split between developed and developing nations. If free trade is the policy going forward, then following the free trade logic, developed countries should continue to specialise in those areas where they have an advantage (technology, innovation, services), and developing countries should continue to supply them with the raw materials to do it.

In other words, the areas where the developing countries have a comparative trade advantage are in industries that are labour-intensive. And those are the industries that they will focus on, because that is where they can compete.

The implication of that: the best way for them to compete is to continue to breed large populations to keep labour costs low and competitive relative to the technological advances of the developed world. So they’ll just stay “developing” – because that’s where their trade advantage lies.

But large unskilled populations are extremely vulnerable to global shifts in demand for raw materials. And so the employment rates are likely to be volatile, which leads to its own sort of political instability.

At the same time, the less skilled workers in developed countries are going to be uncompetitive, with no real alternative but to up-skill (if they can), or settle for non-manufacturing unskilled jobs (like service jobs, which cannot be exported so easily).

Problem 2: who does the “societal loss” belong to?

The gains from cheaper imports will accrue to the foreign competition: being those large firms that have come to dominate the world stage.

Agreed: the general consumer will have access to cheaper sugar. But let’s extrapolate that benefit to almost everything being imported. What happens to a country that closes all its industries that cannot compete, to be left only with an importing retail industry? It runs up trade deficits, runs out of foreign exchange, and its exchange rate rapidly depreciates until its local industries can become competitive again.

But at that point, those local industries have been infrastructurally decimated, and it may not be a question of cheapness: it may just be too late.

Problem 3: that graph is misleading

That little picture of societal loss above makes the assumption that sugar workers can just become diamond miners and they can do it today. That is: if a local industry dies, the economy as a whole will still demand goods at the same level that it did before.

Which just isn’t true.

When that tariff falls away, the demand curve shifts inward as the economy loses the buying power of those sugar workers that no longer have jobs. It’s not a static scenario: it’s dynamic. And it’ll stay that way until those sugar-workers can find other work. If they can.

The real question is actually: will the societal loss of the tariff be greater than the society’s loss of the purchasing power of the former sugar-workers?

And that answer is not so self-evident.

Finally, a big problem (in my mind) where free trade is concerned is that it’s not accompanied by free movement of labour. We’ve created artificial nation lines on a map and then fenced them off with border control and red tape. Now, the WTO wants the movement of goods to be free of the red tape: but not the people that are involved in their manufacture.

That’s just not fair. If the manufactured goods can flow freely, then the labour must flow freely as well. Otherwise, you have labour forces that are either cursed, or blessed, by nothing other than geography – with no right to make the best of it. And, sometimes, you have people that just don’t want to move. They want the blessing of their environment without any of the inconvenience of being economically unviable where they live.

And the response to that kind of ‘unfairness’ is protectionism. Because if you don’t want ours, then we don’t want yours.

And also, we don’t want to move – and we can’t have you doing the work over there because that means that we can’t do the work over here – so your work can’t come in.

Thus: tariffs.

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.