The free movement of production factors is enshrined in the economic imaginary; a standing that emanates from an unquestionable mathematical truth: that is, the greater the number of degrees of freedom to allocate economic inputs –which no question increase with free trade and immigration – the greater the potential to maximize production. This simple and … Continued
The free movement of production factors is enshrined in the economic imaginary; a standing that emanates from an unquestionable mathematical truth: that is, the greater the number of degrees of freedom to allocate economic inputs –which no question increase with free trade and immigration – the greater the potential to maximize production.
This simple and powerful argument conceals nevertheless a major flaw; since the maximization of the whole does not necessarily imply the optimization of the parts. In fact, the latter rarely happens, and someone (countries, regions, industries, individuals) must give in for the common good.
The liberal credo has built a number of theoretical defenses against this fact. The most notable being David Ricardo’s law of comparative advantage, which states that by specializing on producing those goods for which each country has a relative (not absolute) edge, everyone can benefit from trade.
Obviously, the moment a country opens up to trade it has to adjust its productive structure, shut down uncompetitive industries, and concentrate only on those with greater possibilities of succeeding on a global scale. Admittedly, such a transition can be very painful for the workers affected but – here comes the next lifeline to the theory – the economic gains achieved at the aggregate level imply that it is only a problem of finding the right internal redistribution policies.
On the opposite side, there are two powerful economic justifications for protectionist policies. One of them is the well-known “national interest” argument. Blindly pursuing productive capacity in those industries where a country has a competitive advantage, renders the country dependent on others (weakening national security). Moreover, it does not allow the country to move higher up in the value chain, as government support is often essential for nurturing “infant industries”.
A second (often silenced) argument against free trade is the advantages from “buying local”. When consumers dump a local product in favor of a cheaper imported one, or when jobs are lost because production is moved abroad, there is a net capital loss for the country (less tax revenue, more social expenses) – particularly when the efficiency gains do not revert back to the country in the form of corporate taxes, since corporations can arbitrate the international tax system.
Because this loss is both widely distributed across society, and very difficult to quantify precisely, consumers fail to factor it into their purchasing decisions. Moreover, there is a strong incentive for piggybacking on others (to benefit from having industry or local commerce, while buying online abroad).
Imperfect information and non-excludability are two prominent types of market failures that speak for government intervention. The latter can come in the form of tariffs, quotas, tax breaks for local businesses, or government subsidies. All these measures are imperfect and can create economic distortions, but as with taxes, the challenge is to calibrate them correctly instead of abolishing them altogether.
In fact, as often happens with idealized economic models, the free-trade argument fails to reflect the real world. It suffices to have a look at the WTO statistics to realize we still live in a world where barriers to trade are ubiquitous. After all, it is not about having to choose between free trade and autarchy, but – giving credit to President Trump – to seek a “smart trade” that protects national interests.
Fernando de Frutos, MWM Chief Investment Officer