Why Trade Wars Are Good For Trade

7 April, 2010

Economists know that international trade is mutually beneficial. Barriers, such as tariffs and quotas, reduce consumer choice and make goods more expensive. And after all, what business has the state in precluding your mutually beneficial exchange just because the counter-party is a foreign citizen?

Unfortunately, international disputes can put free trade in jeopardy. When states respond to apparent ‘distortions’ by slapping tariffs on incoming goods, they’re trying to retaliate. In reality, they’re hurting their own citizens. What good could possibly come of trade wars?

Today, the line between ‘foreign’ and ‘domestic’ producers is more blurry than ever before. The MacBook I’m typing on right now was sold to me by an Irish retailer, having been assembled in China from parts produced in Taiwan and Korea. It was designed by American engineers, and some of Apple’s profits no doubt return to private investors here in Ireland too. Who benefited from my purchase? Lots of people, some foreign and some domestic.

Even if international trade wasn’t integrated in this way though, tariffs and quotas would still hurt domestic consumers. Unfortunately though, there are strong interests aligned with governments throughout the world determined to restrict trade and maintain their dominant position in markets free from foreign competition. This is a simple example of a collective action problem: small groups of firms and workers find it easier to organise themselves than millions of disparate consumers – even when the benefits to the former are outweighed by the costs to the latter.

This isn’t the whole story though. Many consumers just support protectionist measures because they think free trade sends jobs overseas. They don’t understand the full benefits of free trade, and it is this ignorance that allows governments to retaliate and spur trade wars. Think of the Republicans complaining about China’s undervalued currency.

What have we learned? Firstly, game theorists would say that removing restrictions is a dominant strategy in determining optimal trade policy. No matter what the other guy does, you should always try to keep trade as free as possible. Secondly, some governments don’t determine their trade policy with regard to the greater good and will instead try to subsidise or otherwise benefit their exporters. Thirdly, if you give the irrational, ignorant public an excuse, they will try to slap trade barriers on your goods and services. So much for the dominant strategy.

What if  the public knew the truth and adopted the dominant strategy instead? Then foreign nations would suffer no punishment or retaliation if they imposed trade restrictions on our exporters. They would exploit this advantage by benefiting their favoured firms and importing goods into our markets. If we threatened to retaliate, they wouldn’t believe us – it’s not a credible threat because we know we’re hurting ourselves in the process.

So how do countries maintain a credible threat of retaliation under the status quo? By hiding the costs from the consumer, and exploiting his ignorance. If they knew the truth, would consumers suffer trade restrictions on imported goods in order to benefit a single exporting firm? Probably not. The threat of retaliation is only credible under the status quo because it’s not rational.

Revenge isn’t rational in general. If somebody does hurt you, it’s never optimal to follow through on a threat of vengeance. The threat of vengeance is only credible because the decision to pursue it is not rationally considered. So in a world with free trade on the edge of a knife, it’s not so bad that the public sometimes cry out for trade restrictions. If they didn’t, our deterrence of same would lack all credibility.

© The Free Marketeer 2010


Fair Trade For Some, Poverty For Others

7 March, 2010

Some of you will know that the past two weeks have been  ‘Fairtrade Fortnight’, and today brings the end to an exhaustive media campaign persuading consumers that they should switch over to Fairtrade products.

It’s all very well-meaning, and certainly makes consumers feel good about themselves. But does Fairtrade actually make life better for the poorest farmers in the world? The more ethical policy would be to embrace free trade and stop keeping prices artificially high.

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Can Pakistan Survive the Return of the Taliban?

25 November, 2009

Conventional wisdom holds that Pakistan could become at risk of destabilisation in the event of a US exit from Afghanistan. Indeed, the most persuasive practical case for bolstering troop numbers comes from Stephen Biddle of the Council on Foreign Relations (CFR).

Presumably, empowerment of Islamic fundamentalism in Afghanistan would lead to spill-over effects, and thus empowerment of Islamic fundamentalism in Pakistan. Is it really that simple though?

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The Importance of Property Rights

27 October, 2009

Afghanistan FlagThe New York Times discusses the diversity of revenue streams which support the Taliban in Afghanistan. In recent months, US forces have begun to express doubt over whether a policy to damage the opium trade will really hurt their finances.

Surprisingly, lessons can be learned from Peru’s experience fighting the drug trade and the ‘Shining Path’ guerilla movement in the early 1990s. In that case, the forces aligned against the government drew their power from an unlikely source.

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Turning The Tide

12 October, 2009

SaplingPresident Hu Jintao of China was lauded at the UN climate change summit last week for his bold plans to counter global warming, reports China Daily. His remarks represent a turn-around in China’s attitude and policy.

It is all very reminiscent of the Slave Trade Act of 1807, which banned the international trade of slaves in the British Empire. For fear of becoming economically uncompetitive, the British went on to tirelessly campaign against the practice elsewhere.

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Where Do We Go From Here?

3 October, 2009

European FlagIt now looks like Ireland will pass the Lisbon Treaty. Remember the last referendum? There was literally no mention of many important issues which were lauded by the ‘Yes’ side this time round. Truly, it is difficult to blame the Irish people entirely for being skeptical the last time around.

There are valuable lessons to be learned from the whole fiasco, which started with the rejection of the European Constitution by Dutch and French voters in 2005. It’s time for everyone in Europe to start asking themselves: where are we heading with the European Union?

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Is Voting ‘No’ Europhobic?

26 September, 2009

European FlagDeclan Ganley writes in the Irish Times that another rejection of the Lisbon Treaty by the Irish people will not deter foreign direct investment to Ireland. However, to commentators in the US and elsewhere, the impression now is of a ‘two-speed’ Europe.

I would like to ask Mr. Ganley: If he was a foreign businessman with naught but commercial interest in our small island, would he feel more confident or less confident investing in Ireland on the assumption of indefinite privileged access to European markets after a ‘No’ vote? Under such completely hypothetical circumstances, I have no doubt that his interest in our nation would evaporate.

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