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


Why Tax Breaks Aren’t Bad

23 March, 2010

The economist Robert H Frank in his book ‘The Return of the Economic Naturalist’ completely dismisses the case in favour of tax breaks for the rich (a policy aggressively pursued by the then Bush administration). As far as boosting employment is concerned, he claims, it doesn’t matter what tax rate business owners are paying.

If the addition of another worker to the company is profitable, the entrepreneur will hire him regardless of what tax rate he is paying. This is the decision criterion of the rational utility-maximising capitalist, he says. Although Frank’s logic is extremely elegant, it is ultimately flawed.

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Do Old Boys’ Clubs Make The Market More Efficient?

2 March, 2010

Companies operate in a world of uncertainty. Candidates for employment can only communicate so much information to differentiate themselves, with the result that firms search for innovative ways to identify talented graduates.

Whether you call it networking, cronyism or simply the Old Boys’ Club – using contacts and connections to obtain an edge in the job market seems necessary in today’s competitive world. Should proponents of meritocracy really condemn such mechanisms?

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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..

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The Economics of €2 Spar Hot Chicken-Fillet Rolls

12 November, 2009

SandwichThe recession has brought down prices throughout the economy, in response to faltering demand. In Dublin, the most poignant example of this is Spar’s much celebrated €2 hot chicken-fillet roll.

But in the same shop, many prices haven’t fallen as much. Why is this? Like the canary in the coal mine, the €2 hot chicken-fillet roll acts as an indicator in case of recovering consumer spending.

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Why Fees Aren’t Free

9 November, 2009

The decision by the Irish government to repeal the reintroduction of fees has been met with joy by students around the country. But ‘free fees’ promotes inefficiency and propogates inequality, by not imposing the true cost of education on students.

Those who criticised the reintroduction of fees claim that students couldn’t afford to pay them, and that access to education would be limited as a result. Unfortunately, inequality in educational opportunity may stem from differing financial conditions – but free fees does nothing to stop this. As long as wealthier families can gain an advantage through spending (either through private tuition or grind schools), they will do so.

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A Different Kind Of Carbon Leakage

3 November, 2009

Red FoxThe Irish Government recently decided to ban fur farming in Ireland. Their justification for this, presumably, stems from concern for animal rights and the cruelty of the practice.

In fact, this measure may end up harming animals – by pushing fur farming out of jurisdictions with responsible and concerned governments, they are forcing fur farming into more permissive and cruel states.

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