Protectionism: A threat to Individual Rights
by Dr. Edward Younkins
Professor of Accountancy and Business Administration at Wheeling Jesuit University in West Virginia and author of Capitalism and Commerce.
Free trade recognizes the right of individuals to engage in voluntary transactions in goods and services across international borders. In addition, free trade creates jobs by reducing prices. With more money left in the hands of consumers, their additional spending will stimulate production and employment. Furthermore, free trade shifts jobs from high relative cost sectors that cannot compete to low relative cost sectors that may be able to compete. When individuals voluntarily purchase an imported article they get a superior product and/or a better price. Free international trade imparts benefits on all countries, firms, and individuals that participate by permitting, on an international basis, the specialization that occurs in a free economy.
Protectionists overlook the benefits of specialization and comparative advantage. A tariff diverts production from countries where output per unit is higher to countries in which output per unit is lower. In addition, a restrictive trade policy reduces person to person contact and social harmony, increases provincialism, invites retaliation, and stifles innovation (by reducing competitive pressures). Furthermore, and most importantly, import restrictions violate individuals’ freedom to exchange.
The Law of Comparative Advantage
Specialization is made possible and desirable by comparative advantage. It is always beneficial for a country to specialize in what it can produce best with the resources available to it and to trade with others to obtain other products.
The law of comparative advantage declares that every nation can improve its economic position by specializing in the most efficient product lines available to them. These product lines are those in which its productivity relative to other product lines is greatest. It follows that even the country that is least efficient in producing every product will benefit from free trade. It does this by specializing in what it is only somewhat inefficient in producing.
Total economic well-being is thus furthered as each person, region, and country specializes in providing those goods and services which it can produce, in relative terms, most efficiently. International trade is a positive-sum activity that increases the wealth and employment opportunities of all countries by permitting them to capitalize on their comparative advantages in production.
Trade benefits are based on relative production costs rather than on the level of production costs. Every nation has a relative cost advantage in some pursuit. A country such as the United States has lower relative total production costs in some endeavors because of its high labor productivity and low capital costs. Another less industrialized country’s comparative advantage with respect to another product is likely to be due to its lower labor costs. Free trade allows one country to benefit from the comparative advantages and specialization in production found the world over. It is through the price mechanism that individuals and nations discover their comparative advantages.
At root, the issue of tariffs and other trade barriers is a moral concern. To place such restrictions on the exchange of property is an infringement on the natural right to own and exchange property. Protectionism threatens the consumers’ rights to choose from among goods and services. Protectionism is the policy of using coercion to restrict imports of foreign goods.
To argue for tariffs and other trade restrictions is the same as arguing against technological change and human progress. Trade barriers decrease the advantages gained through the international division of labor. The argument for protectionism is the argument for higher prices, lower quality goods, economic stagnation, and coercive monopoly.
Protectionists maintain that permitting consumers to purchase foreign made products causes unemployment at home. We are told that jobs are lost when we are invaded by cheap foreign goods. Protectionists argue that tariffs and quotas keep domestic wages from being reduced to the wage levels in countries from which we import. When firms within certain industries call for protection to allegedly protect consumers from poor quality products and to ensure their employees’ jobs, their real goal is to gain security through the removal of competition.
The real effects of protectionism are to reduce consumer choice, to raise the price of protected foreign products and domestic goods, to misallocate resources, and to lower worldwide production. Protectionist policies may “save” some jobs in a specific industry, but only at the expense of the overall welfare of the country. Tariffs promote the production of items in which a nation is inefficient and deter other production lines in which the country has a comparative advantage. By repealing tariffs, things that could be produced more efficiently in one country would be made there and items that could be purchased less expensively abroad would be imported.
Protectionism temporarily helps some producers, but it cannot do this without harming others. Who is hurt by tariffs? First there are those who buy a product upon which the tariff has been levied. Consumers of the tariffed foreign good and consumers who buy an American made product at a high price that is protected by the tariff both bear the cost of the tariff. Both foreign and domestic producers can raise their prices as the result of the tariff. Purchasers would have less wealth to spend elsewhere. Further, there are the nonconsumers who would have entered the market if the lower price had been in effect. Also injured are domestic firms that now sell fewer goods because Americans have to spend more to purchase the tariffed products. In addition, American companies would necessarily export fewer goods because foreigners have made fewer dollars in America to pay for American exports. Trade restrictions on imports are also restrictions on exports. When we purchase foreign products, we actually create American jobs as dollars come back to the U.S. as payments for American made goods, as investments in America that beget domestic job opportunities, or to pay off debt burdens.
Also harmed by a tariff is the foreign importer who earns fewer profits. Oftentimes, the consequence is retaliatory tariffs imposed by foreign governments on our products going abroad.
If a foreign country imposes a tariff on our products, our best response is not to retaliate at all. In fact, we should drop all tariffs and increase imports of the products of the offending nation. Foreigners in that country would then have a lot of paper dollars that they could use to purchase our products. We would have real foreign-made consumer goods in our possession, but would only be giving up paper currency. Imports are our gain from trade – the more goods, the better. When a country chooses not to retaliate, it provides its citizens with the benefits of free choice. Any country would benefit from eliminating tariffs and import quotas, even if other nations do not reciprocate. A country should not misallocate its resources and give up the benefits of specialization just because another nation does that to its inhabitants.
Certainly, if a tariff is removed, some workers in the protected industry may lose their jobs and some or all of the firms in the protected industry may be forced to close by the foreign competition. Workers will have to look for employment elsewhere. However, other job opportunities will be made available since the money that consumers previously had to pay for tariffs could be used to buy or produce new products or services or more of already existing products and services. Employment is created in other sectors because free trade permits resources to flow to areas that consumers consider being of highest value to them.
Protectionism benefits a relatively small group of special interests. There would be more people employed in protected activities, but at the expense of fewer people employed elsewhere in the economy. For example, trade barriers in the steel industry may save jobs in that industry for a short time period, but at the cost of destroying even more jobs elsewhere. American automakers would pay more for steel. This would lead to higher prices for American cars thus reducing sales and ultimately causing lay offs of employees. Higher steel prices raise the costs of building cars in Detroit and promote the American sales of Japanese auto makers whose final products embody the tariffed material, steel.
Contrary to protectionists’ claims, cheap foreign labor does not constitute an unfair advantage. As long as the productivity of American workers is greater then they are not at a disadvantage. The reason that labor is less expensive in some countries is because their workers have lower productivity. High wages are found in nations in which workers’ productivity in high and low wages are found in nations where productivity is low. American wages are higher because the marginal productivity of U.S. workers is higher. U.S. workers have greater productivity primarily because of the capital equipment with which they work. In terms of labor cost per unit of production, the average American worker is the lowest paid worker in the world. Due to the use of tools and equipment, his productivity to wages ratio is far greater than the productivity-to-wages ratio of workers in other countries. Because of the plentitude of capital equipment, U.S. workers relatively provide the least expensive labor in the world.
What dictates a country’s comparative advantage in international trade is the relative total amount of resources used to produce a product, not solely the labor utilized. Low-wage nations import American goods because the U.S. has a comparative advantage in producing some goods, regardless of our seemingly higher wages. Whereas one country may have a comparative advantage in one product area due to its lower labor cost, another country may have a comparative advantage in another product area because of its low capital costs and high labor productivity. Whatever the particular scenario, low wage countries must ultimately do something with the dollars they gain from the sales they make to Americans.
A tariff levied against “cheap labor” products would economically hold back foreign workers and keep domestic consumers from purchasing less expensive products. Such a tariff would also maintain American workers in industries where they have no comparative advantage and keep them out of areas in which they would be most productively employed. Free trade shifts jobs from high relative cost sectors that cannot compete to low relative cost sectors that can compete. The case for free trade is the case for lower prices, higher quality goods, economic growth, and competition.
Trade Deficits Should be Welcomed
Many people believe that a trade surplus is good while a trade deficit is bad, that imports decrease profits and eliminate jobs, that being a debtor nation is unhealthy, and that a nation’s economy is better when it exports more than it imports. People refer to a trade deficit as exporting American jobs. Actually, being a debtor nation and having a trade deficit are not bad situations for a country to be in.
Part of the problem may be due to the arcane definitions used in “balance of payments” accounting. To begin with, the balance of trade is the difference between the money value of a nation’s merchandise imports and the money value of its merchandise exports. A more inclusive measure, the balance of payments includes merchandise transactions, credit transactions, and government payments (e.g., foreign aid) abroad. The balance of payments portrays trade patterns. Whereas the current account measures flows of goods and services, the capital account measures flows of funds and financial assets. There is no real balance of payments predicament. By definition, the balance of payments always is in balance. For example, if there is a current account deficit then there has to be a reciprocal capital account surplus. A current account goods and services trade deficit is balanced by a favorable investment surplus. Foreign private individuals, companies, or governments must be acquiring more real or financial American assets than American individuals, companies, or governments are amassing foreign assets.
The balance of trade idea has its roots in the mercantilist period of the 16th to 18th centuries. Mercantilism is based on the notion that a country gains wealth only by exporting its goods. According to mercantilist writers, a nation should never import more from foreigners than it exports to them. If it did, the country would have to pay the difference in gold (i.e., specie). The nation could thus accumulate specie by exporting more goods than it imported. Mercantilists taught that the gold flow into the country would encourage the nation’s economic power and productivity.
However, as gold flows in, money would become more abundant and goods would become more scarce. As a result, prices would rise and foreigners would reduce their imports so that they could purchase less expensive goods at home. Consumers in the home market would then import cheaper foreign goods and export gold. In other words, gold inflows would increase domestic prices and consequently discourage exports while encouraging imports.
Today, in the absence of such gold flows, foreigners must have a supply of the exporting country’s domestic currency if they want to buy the exporting country’s domestic goods. The supply of obtainable currency dwindles as the demand for goods persists. The price of the exporting domestic nation’s currency rises making it more expensive to acquire the currency necessary to purchase the goods. Sensibly, foreign buyers will shift to their own or other markets.
Supply and demand for various currencies regulates exchange rates. Exchange rate adjustments balance the supply and demand for respective currencies to correspond to the supply and demand for goods, services, and investments that could be acquired with the different currencies.
Trade is a two-way street. The dollars Americans pay for foreign made products ultimately are re-spent in America thereby creating domestic jobs in the exporting sector. Foreigners must either spend dollars in our country or sell them to someone who will spend them here. We can trade dollars for products only as long as foreigners want dollars or U.S. goods. If they do not want American dollars or goods then adjustments will be made in the value of the dollar.
In a trade deficit, one nation is giving up dollars and the other nation is giving up products. It is a matter of taste, preference, and choice regarding which is more valuable – the dollars or the goods. How can nations be hurt by a trade deficit if individuals are not? A nation is not an entity to which economic principles apply. There is nothing unfavorable about voluntary trade from the perspective of the individuals involved in the trade. They would not have made the trade if they judged it to be unfavorable. Nations do not trade – only individuals do. If each individual gains in every trade, then how can the entire nation be harmed by a trade deficit?
A trade deficit consists of a net transfer of dollar claims from American individuals to foreign individuals. The dollars received by foreigners will either be spent on American real goods and services or invested in American capital and equities markets. When dollars are returned for real American goods and services, they directly stimulate our domestic employment. On the other hand, if the dollars are invested in U.S. capital and equities markets, then foreigners may actually be helping to build new facilities in America thereby stimulating the creation of new American jobs. Of course, they could choose to buy an existing business rather than start a new one. Foreigners could also leave their money in a U.S. bank account. The bank, in turn, would lend the money to American citizens to build homes or for other purposes and to American companies to build new facilities, develop new product lines, etc. Finally, foreigners could use their dollars to purchase U.S. Treasury notes thus liberating and allowing Americans’ savings to be available for capital investment.
When a trade deficit increases, net foreign investment in the U.S. also necessarily increases. These occurrences are simply two sides of the same coin. Being a “debtor nation,” like America since 1985, means that foreigners invest more in the U.S. than U.S. citizens invest abroad. The influx of foreign capital into our economy is beneficial and should be welcomed. Foreign investment in the U.S. provides jobs and stimulates economic growth. Or, put another way, trade deficits actually bring economic health. It is a myth that trade deficits cost American jobs.
Finally, it is interesting to note that protectionists are impossible to satisfy with respect to foreign trade. On one hand, they grumble when money leaves the country (i.e., when imports exceed exports. Then, when dollars return to America in the guise of foreign investment, they bemoan that an excessive amount of foreign money is entering the country and that America is being taken over by foreigners!
Let the Dumping Begin
Protectionists have used the term “dumping’ as a vague negative refrain. Dumping has been defined as selling abroad below cost or at a lower price than that prevailing in the home market of the exporter. A problem with the “below cost” type of definition is that costs can be computed in many ways. A single cost just does not exist.
No matter which definition is being employed, we can safely say that dumping refers to the existence of extremely inexpensive imports. Dumping results in the dumper losing money while the purchaser has saved money that can be used elsewhere. When goods are dumped into the American market, U.S. consumers enjoy lower prices and increased purchasing power.
Temporarily lowering prices is a common business practice. There are many sound business reasons for lowering prices (i.e., dumping) in foreign markets. For example, firms finding themselves with excess inventories may decide to sell below the normal retail price. Some products may just no longer be in great demand in one’s home market. In addition, a producer may want to continue a certain production level during an economic downturn at home. In such a case, it may be better to sell products abroad at a lower price than to shut down production for the duration of the economic downswing. Also, foreign monopolists, unable to attain more domestic sales, may be able to increase their profits by expanding sales in foreign markets. As long as production costs are met by foreign sales, the decrease in per unit production costs will increase earnings in the domestic market. This can occur when a company is experiencing increasing returns to scale in production. The foreign market enhances the home market giving rise to economics of scale.
Then there is so-called “predatory dumping” in which foreign firms are alleged to dump their products in an attempt to drive their competition out of business with low prices. Protectionists say that the foreign dumper will then raise his prices. Such a dominant position will be difficult to achieve and maintain. Efforts to later raise the product’s price above the competitive price would attract others into the market and force the prices down. In addition, given that predatory dumping is perceived as such, all domestic competing firms would need to do to spoil the dumper’s plans is to cut production during the dumping period and keep capacity available for production subsequent to the dumping period.
We should not only permit but also encourage foreign firms to sell their goods below cost or below the home price. We can improve our standard of living by consuming their final goods and utilizing their intermediate goods to reduce our production costs.
Of course, the domestic firms competing with the foreign dumper will confront a challenge. They will need to cut costs, at least temporarily shift production to other goods, differentiate their products, etc.
Free Trade Promotes Peace