Episode 35: Why do countries restrict trade?
In Episode 34, we saw that the practice of
free trade according to comparative advantage results in lower buying prices, higher selling
prices, and greater global production, all of which means improved living standards.
Do you know how many countries in the world are engaged in trade? Every single one — there’s
not one country in the world that’s completely self-reliant. And do you know how many countries
around the world practice completely free trade? None. Not one single country practices
trade free of any restrictions. So if free trade is so fabulous, then why do all countries
put restrictions in place? Perhaps it’s best to take one step backwards
and ask: who has the power to put trade restrictions in place? That would be each country’s government.
Why would the government put such restrictions in place? The government places trade restrictions
in order to protect domestic industries from foreign competitors. Now ask yourself this:
which domestic producers would seek such protection? Surely not all of them; some domestic producers
already have a natural advantage in production over the foreign competitors. This is the
key; the only domestic producers who would need protection are those who would be driven
out of business under free trade — those who have a comparative disadvantage in production.
So what arguments could the weak, disadvantaged producers make to the government to convince
it to provide protection in the form of trade restrictions? Well, there are several. First, there’s the domestic jobs argument:
if some type of trade restriction, say a tax or a quota, is placed on incoming foreign
goods, then consumers will have to purchase domestic goods instead, right? And if the
demand for domestic goods is higher, then the need for workers to produce those goods
is higher. Look at the US steel industry: with protections in place, more US steel is
purchased, and more US steel workers have jobs. The domestic jobs argument is pretty
persuasive with politicians, because voters with jobs are happy voters. Here’s the rub,
though; while trade barriers mean more jobs in the protected industry, they actually cost
jobs in other industries. Think again about the US steel industry: historically, taxes
(called tariffs), have been imposed on imported steel, so the US producers don’t have to compete
at such a low price. But this means that steel will cost more to consumer. Who buys steel?
The auto industry, perhaps? Construction firms? Steel drum manufacturers? Any industry that
uses steel is a resource will face rising costs, which will lead to decreased supply,
which means fewer jobs in all of those industries. So while steelworkers may have more jobs,
workers and all the downstream industries, like auto workers and construction workers,
will lose jobs. On net, especially in a country like the United States where disadvantaged
areas tend to be oh, raw materials are low-end materials, this will result in a net loss
of jobs. Argument for production number two: level
playing field. The logic here is that the foreign producer has some unfair advantage
over the domestic producer, and the trade restriction would just… even things up a
bit. An unfair advantage might be if, say, the foreign producer was receiving subsidies
from its own government, such that costs were reduced, and the foreign producer’s product
could be sold very cheaply in our market. But what happens if the foreign producer just
has an advantage — are all advantages unfair? In 1997, the collapse of the Thai baht kicked
off a wholesale financial collapse in Southeast Asia. As Asian currencies lost most of their
value, becoming very cheap, Asian products became cheap. Suddenly US steel producers
were facing extremely cheap Asian steel, and went to the US government to seek protection.
The question I have is this: did the Asian producers have an unfair advantage? Did they
deliberately plan for their currencies to lose over 90% of their value, just so they
could sell more steel? The term “fair” is a slippery thing, somewhat subject to interpretation.
The other difficulty here is that one country may dispute the “fairness” of another’s
restrictions, and retaliate with restrictions of its own, eventually escalating into a trade
war. A third argument for trade restrictions is
that they can raise additional revenue for the domestic government. A tariff (or a tax
on imported goods) would generate added dollars, as would revenue from the sale of quota licenses.
But in a country like the US, where only a very small percentage of government revenue
comes from traded goods (remember we saw in the budget episode about 90% of federal revenues
come from income tax, payroll tax and corporate tax), does it makes sense to harm consumers
by making imported goods more expensive? The government revenue argument is likely to be
more compelling for governments of poor nations, where there isn’t much income to tax; the
only place to squeeze additional revenue is from businesses, especially internationally. A fourth argument used in favor of trade restrictions
is the national defense argument. If an industry is critical to the national defense, we should
protect it in peacetime to make sure that it’s still around in times of war. Some industries
may spring to mind immediately as being critical to the national defense: tanks, guns, munitions,
aircraft, shipbuilding… but then, what about the metal used in all of these industries?
Shouldn’t that be protected? What about our food supply, or uniforms for our troops? Or
the producers who make buttons for the uniforms? You can see where this is headed — it becomes
difficult to draw a hard and fast line separating industries that are critical to the national
defense from those that are not. This becomes compounded when you realize that in recent
years, the argument has been broadened from “critical to the national defense” to
“critical to the national interest.” For example, some countries have restricted the
amount of US entertainment and publications, like movies and magazines, that are allowed
in, because they feel it would not be in their country’s national interest to allow their
own cultural identities to be swallowed up by US pop culture. The infant industry argument is number five
on our list; this says we should protect and support new industries until they’re mature
enough to compete on their own. I can understand this; in the town where I grew up there was
an economic incubator. If you had an idea for new business, you could put in a proposal.
If you were successful, you’d start up your business in the incubator building, enjoying
lower rent and immediate access to business consultants. After a designated period of
time, your business would move out and someone else would move in. Here’s the drawback with
federal support for a new industry: who is in the best position to know when the industry
is ready to “leave the nest”? The industry is. So if the government goes to the industry
and says, “Hey, you ready yet? Can we take the restrictions away?”, what’s industry
going to say? “Sure, go ahead”? More likely the response would be, “No, not yet. Ask
us again a couple of years.” In the past, some countries would protect these “infant”
industries for decades. In the US, at least, the international Trade Commission (or ITC)
places time limits on protection, and usually weans the industry off by progressively decreasing
the level of restrictions over that time period. There is one more method that goes against
the natural flow of free trade, but it’s less about protecting a weak domestic producer
from foreign competition than it is about giving your domestic producer an artificial
boost into other countries’ markets by subsidizing them, so they can take over market share abroad.
This method of creating international dominance is, of course, squarely in the arena of “unfair
advantage” (see argument number two), and is really an open invitation for other countries
to retaliate against you with restrictions of their own. In this episode I went over many reasons why
government might agree to protect the economic interests of its domestic producers, even
though they have comparative disadvantage in production. Next time, I’ll show you in
more detail how the government can protect domestic producers by using tariffs, quotas,
voluntary export restraints, or nontariff barriers to trade. NEXT TIME: Types of trade restrictions
TRANSCRIPT0 EPISODE 35: WHY DO COUNTRIES RESTRICT TRADE?