Free Trade Is the Path to Peace & Prosperity

 

The backlash to free trade is now crossing what passes for a political spectrum, with protectionism on the rise across Europe and the U.S.—and right here in NZ But protectionism is a threat to both peace and prosperity, argues Georgi Vuldzhev in this guest post.

The political circus of the 2016 presidential election has revived and reinvigorated popular belief in age-old protectionist fallacies. Currently both Donald Trump and Bernie Sanders, are both in favor of expanding protectionist trade policy, with both of them arguing that free trade “destroys” jobs and hurts domestic workers and producers by exposing them to foreign competition. Both candidates espouse an utterly misguided zero-sum view of economics, in which one side to an exchange wins only when the other side loses. Both men are, of course, completely wrong.

Free Trade Does Not Destroy Jobs

It is true that greater competition between domestic and foreign workers can lead to a decline in wage rates and possibly unemployment in some sectors of the economy. But this is only a short-term effect. Free competition between foreign and domestic producers also naturally leads to lower prices for the goods and services which can now be freely imported from abroad. So, while nominal wage rates are pushed down in some sectors, real wage rates rise overall for everyone in the economy because of the decline in prices.

Thanks to free trade, consumers spend less money on certain goods and services and this allows them to spend more money on others, which leads to rising demand and thus profits in the sectors providing the latter, and consequently leads also to more investment by entrepreneurs. This higher rate of investment naturally leads to the creation of more jobs in these sectors and thus offsets any original rise in unemployment that might have occurred.

Alternatively, the consumers may choose to save the extra disposable income that was freed up by the decline in prices. This rise in the savings rate will lead to a decline in interest rates, which makes profitable certain long-term capital-intensive projects which were not profitable beforehand. Seizing the opportunity presented by this increase in savings, entrepreneurs will start borrowing and investing in those long-term capital intensive projects, which on its own already creates more jobs, but it also leads to a rise in demand for capital goods, which raises profits in the capital goods industries and consequently leads to more investment and job openings in those sectors.

Free Trade Is Win-Win

Free trade not only doesn’t “destroy” jobs, but it also promotes specialisation between nations, which improves the efficiency and productivity of workers, and leads to a rise in living standards for all. Trade is not some kind of a zero-sum game in which if one side wins, the other has to lose.

When two countries such as the United States and China, for example, trade freely with one another, their citizens are encouraged to specialise in those lines of production in which they have a comparative advantage. Due to the difference in factors of production-endowments it is best for different countries to specialise in producing those types of goods and services which they can produce most efficiently in comparative terms. A higher level of specialisation, through the effect of economies of scale, makes production more cost-efficient.

By specialising in a certain line of production and then exchanging the goods and services produced for those that others are specialised in producing, the people of a given country can substantially raise their living standards because the gains in productivity are naturally followed by an increasing supply of goods and services and thus rising real incomes. This way free trade allows for the flourishing of what can be called an “international” division of labour. Just like a greater degree of division of labour can lead to big gains in productivity and thus real incomes on an intra-national (i.e., internal for a given country) level it can also do so on an international level.

Protectionism Makes You Poor

Put simply, protectionist tariffs are a threat to peace and a tax on the poor. Every tariff must be paid by a consumer; overwhelmingly those tariffs would be paid by the lower-income folk now enjoying cheaper imports. But it gets worse.

When international trade is restricted by protectionist legislation which, for example, places tariffs on certain imports, the process of specialisation is hindered and thus the gains in productive efficiency are diminished. By artificially raising the price of imports, tariffs allow otherwise uncompetitive and inefficient domestic businesses to remain in operation. Consumers are forced to pay higher prices for the goods the importation of which is penalised by tariffs, and this effectively constitutes a redistribution of resources from the consumers to the domestic producers.

More importantly, protectionism hinders the process of specialisation described in the previous section and thus prevents living standards from rising in the long-term, or worse — it can even lead to their decline. By propping up the profits of comparatively inefficient domestic producers and keeping these zombies in business, tariffs prevent the labour shifting from those inefficient sectors who can pay very little, to more comparatively efficient ones who would be able to pay more. Consequently, because this prevents a higher degree of specialisation from taking place, or even reverses it, the benefits that specialisation leads to cannot be obtained. Productivity does not increase (or at least not to the same degree as it could) and thus real incomes do not rise.

Contrary to the popular political rhetoric nowadays, free trade does not “destroy jobs.” It can only lead to a shift of resources (labour, capital, and other factors) from one comparatively inefficient sector or group of sectors in the domestic economy to another more comparatively efficient one. This process of specialisation in the comparatively advantageous lines of production not only does not destroy jobs, but it also enables big gains in efficiency and productivity to take place, which leads to a rise in real incomes. This is how, far from somehow hurting the domestic workers, free trade actually does the opposite — it makes them richer. It is, in fact, protectionism which makes us all poorer, workers included, by artificially propping up inefficient businesses, leading to a misallocation of resources and a decline in standards of living for us all.

 

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Georgi Vuldzhev is a passionate student of economics and former intern at the Institute for Market Economics in Sofia, Bulgaria. His articles on economics and politics have been published by European Students for Liberty, the Foundation for Economic Education, and various Bulgarian publications.
His main areas of interest are Austrian business cycle theory, international trade and monetary theory.
This post first appeared at the Mises Daily.

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