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


The Market for Power and Influence

17 February, 2010

The College Historical Society recently hosted a debate on whether the decline of American global economic dominance was to be welcomed or feared. It was eventually concluded that America’s influence on the rest of the world was broadly positive: in promoting good state institutions, pro-market policy and international development aid.

This author disagrees however. After all, geopolitics is simply a market for power and influence and America was until recently a monopoly vender. As any economist knows, that’s bad news for consumers.

Read the rest of this entry »


Guardians of the Peace?

9 December, 2009

Ireland’s police force, an Garda Síochána, are threatening to take action in light of public pay cuts. Although not legal according to the constitution, past examples of disobedience amongst law enforcement in Ireland include the ‘Blue Flu’ of 1998.

The reality is that no government can properly negotiate with a national police force on even footing, as long as no real alternative exists. Could private security provide the answer? By supplanting national law enforcement, maintaining accountability, promoting competition amongst service providers, and ensuring that society cannot be blackmailed by public workers with the threat of chaos.

Read the rest of this entry »


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?

Read the rest of this entry »


Why Tobin Taxes Wouldn’t Have Prevented The Financial Crisis

24 November, 2009

The Economist discusses the populist rhetoric from Gordon Brown on the topic of the Tobin Tax, a fee levied by government on any financial transaction. US Treasury Secretary Tim Geithner admits that any such policy would be useless unless adopted world-wide, because trading would simply migrate to unregulated jurisdictions.

Public support for such measures is worrying though, as the Tobin Tax is ineffective in preventing risk-taking in financial markets or harmful asset price bubbles. It would be extremely effective at making markets inefficient though..

Read the rest of this entry »


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.

Read the rest of this entry »


Sharing Amongst Enemies

30 August, 2009

Cherry PieIn his book Partitioning for Peace, Ivan Eland argues that division offers the best chance for peace in Iraq. He outlines lessons that can be learned from historical examples of partition.

However, he makes little of precisely how oil revenue is to be shared amongst the different peoples. Rather than divide the land and the oil by proxy, it would be much better to centrally process the oil and divide the revenue.

Read the rest of this entry »