A recent email exchange with Thoreau at Unqualified Offerings got me thinking about the best, jargon-free way to explain one of the most counter-intuitive results of international trade theory. Thoreau is a really smart dude, what with being a physicist who’s starting a tenure-track position at a reasonably notable California university this fall, but in most of our exchanges about trade he hasn’t quite gotten one of the key points about why free trade won’t sustain itself in the long term. In this case, I’m going to go ahead and blame the communicator here because I have a noted tendency to write overlong sentences like this one and to write in a formal tone laden with technical jargon. That tendency is a failing, and I’ve been thinking about how to clearly explain what I’m talking about for the last couple of days. As such, onward!
The counter intuitive result I’m talking about is pretty simple: sometimes a country can make itself better off by imposing some kind of trade restriction. This can happen when a country makes enough widgets to affect the price of widgets on the global market, not just in their domestic market. This doesn’t seem to make a lot of sense, because the typical story goes something like this: We’re better at making widgets, you’re better at making whatsits and so we’ll trade and both be better off! In that kind of circumstance it seems pretty obvious that nobody can benefit from restricting the free flow of widgets and whatsits between the countries. Well, in truth the story is more complicated than that.
Let’s start by imagining that instead of countries we treated the whole globe like it was all one big country with a bunch of states. That means that restricting trade between the US and China would be a lot like restricting the trade between California and New York is now. So, then, obviously you’re not going to make Earth better off by restricting trade between the US and China. But what about the US or China? Well, that might be a little bit different.
If both countries have enough, for want of a better term, market share in widgets or whatsits that the price on Earth can be affected by the price in the US or the price in China, then things turn out a little differently. Let’s say, just for the sake of argument, that the US decides it doesn’t much like getting so many whatsits from China: maybe US producers of whatsists are complaining that they’re having a rough time of it, maybe China has become politically unpopular in the US, whatever. So the US decides to impose a quota on the importation of Chinese whatsists, which sets a cap on the number of whatsits from China that are allowed to come into the US. Further, because this makes the story simpler (but leaves the point the same), let’s suppose that the US and China are the only people on Earth who make whatsits.
So, the US imposes this quota, and the number of whatsits coming into the US from China falls. What happens next? Well, it’s safe to assume that US consumers still demand the same number of whatsits they wanted before, but now they can’t get enough to meet demand because they can’t import those that US makers of whatsits weren’t making…so the price of whatsits in the US goes up. Well, that means that US makers of whatsits will start making more to meet that demand. So, in the US the price goes up, but US producers make more whatsits and thus more money. So, US whatsit producers benefit from this quota and US consumers are hurt. Additionally, those Chinese producers who are still allowed to sell in the US may benefit: if the right to sell in the US is sold, then the US government benefits, if it is given away then the Chinese producers benefit.
What happens in China? Well, the price of whatsits will fall in China because there is now less demand for Chinese whatsits. That means that Chinese whatsit consumers benefit. But this lower price also harms Chinese producers of whatsits: lower demand means a lower price, less profit, and less production.
No matter what, this has reduced the welfare of Earth, because any time you interfere with a competitive market some of the welfare simply evaporates from the distortion. But, if the quota isn’t too big the US government forces a transfer from Chinese producers and US consumers to US producers, Chinese consumers, and either some foreigners or the US Government. If the quota isn’t too restrictive, this will actually raise the total welfare for the US while harming the welfare for China and Earth. In fact, there is some quota that will maximize US welfare, meaning that if the US is only thinking of its domestic welfare, it would certainly impose some quota on Chinese whatsits.
This isn’t to say that striving for free trade and attempting to make as many people as possible as well off as possible isn’t the morally correct thing to do, or to say that free trade isn’t a good goal, but to note that things can be a lot more complicated when you have to think about how nations will act toward each other, and that you have to tailor your arguments in those terms. In many cases it may be better to tout the moral benefit of helping people from other countries through mutually agreeable trade than to try to justify the dropping of all trade restrictions from shaky economic footing.
I hope that made a reasonable amount of sense. I didn’t even draw a graph or say “utility” or anything.
[…] Unfortunately, those sorts of problems: high infant mortality, bad diet, long work hours in bad conditions, and crushing material poverty, are still a daily reality for much of the world’s population. And this ties directly into what I mentioned the other day about the moral case for trade. […]
The One-Handed Economist » Blog Archive » The End Becomes The Beginning
August 30th, 2007