2 November 2017
Remarks at the Institute for Free Trade’s inaugural “Global Trade Summit” at Mercers’ Hall, London, celebrating the 200th anniversary of the theory of comparative advantage on October 16, 2017.
200 years ago, David Ricardo developed the theory of comparative advantage to explain why countries engage in international trade even when one country’s workers are more efficient at producing every good than workers in other countries. He demonstrated that if two countries capable of producing two commodities engage in trade, then each country will increase its overall consumption by exporting the good for which it has a comparative advantage while importing the other good. Widely regarded as one of the most powerful yet counter-intuitive insights in economics, Ricardo’s theory implies that comparative advantage rather than absolute advantage is responsible for much of international trade.
As Harvard economics professor Greg Mankiw said: “Few propositions command as much consensus among professional economists as that open world trade increases economic growth and raises living standards. The insights of Smith and Ricardo are now standard fare in Econ 101.”
So while there is a strong consensus among economists that free trade produces positive net benefits, increases economic growth, and raises living standards why is there is so much misunderstanding and resistance among the general public to free trade, and why is there so much political support for protectionism?
There is also a strong consensus among economists that protectionism will harm economic growth, eliminate net jobs, destroy prosperity, and lower the standard of living of the protectionist country. That’s because protectionism is guaranteed to generate costs to consumers that outweigh the benefits to producers. Therefore, protectionism inflicts great economic damage on the protectionist country, and that can easily be demonstrated using international trade theory.
There is also plenty of empirical evidence showing that protectionism and tariffs always generate costs to consumers that far exceed the benefits to producers, and in terms of the cost per job saved, protective tariffs typically cost consumers more than $500,000 in higher costs on average for every job saved, according to a study the Peterson Institute of International Economics that looked at several dozen case studies of protectionist trade policy in the US.
So why is protectionism being taken so seriously, and given so much credibility, when it’s actually a job-destroying, prosperity-destroying form of economic suicide?
It’s because of the distorted way the costs and benefits of protectionism are considered.
The US sugar example
Take the case of protectionism for US sugar producers in the form of sugar tariffs and restrictions on sugar imports into the US. It’s a great case study and unique because we can actually observe the effects of that form of protectionism on a daily basis. In contrast, the costs of most protectionist policies are hidden and invisible.
In the case of sugar, there are two futures contracts traded daily in New York, London and Singapore: one for sugar at the world price, currently about 14 US cents per pound, and one for sugar at the US price, currently about twice that amount at 28 US cents per pound. That 2:1 price ratio has existed for centuries, since the U.S. sugar industry has enjoyed trade protection since 1789 when Congress enacted the first tariff against foreign-produced sugar.
The burden of those higher sugar prices is imposed on American consumers who pay more than $3 billion per year in unnecessarily high food and sugar prices. But let’s say the $3 billion in higher costs are spread pretty evenly over about 300 million Americans who pay about $10 per year in higher sugar and food prices.
There are about 5,000 sugar beet and sugar cane farmers in the US, and let’s say they collectively share about $1 billion annually in higher revenues due to sugar protection, or about $200,000 per year per producer.
The cost to consumers is dispersed and invisible, so that consumers don’t even notice the $10 per year in higher food prices, and even if they notice they have no incentive to organize as a grassroots consumer group to try to go up against Big Sugar.
Conversely, the generous benefits to sugar producers are very large and visible and concentrated on a small group of farmers, who therefore have a strong incentive to organize as a special interest group, and who find it very easy to organize through an industry trade group like the American Sugar Alliance, the main lobby group for American sugar growers, which spends about $2 million per year to protect the Big Sugar cartel.
So when you understand that the benefits of protectionism are concentrated on a small group of producers who are well-organized and politically powerful and the costs are diffused over hundreds of millions of rationally ignorant consumers who are not organized and not politically powerful, then you can understand why we have many examples of protectionism in the US and around the world, even though the costs imposed on consumers are greater than the benefits received by producers, it costs the economy several hundred thousand dollars or more in higher costs per job saved, and leads to a loss of jobs on net.
In the world of economics, going back to Smith and Ricardo, we recognize that the benefits of free trade are greater than the costs, and it makes us better off. Further, we understand that the costs of protectionism are greater than the benefits, and it makes us worse off.
It’s only when we enter the world of politics, that sound economics is ignored in favor of politically favored outcomes that impoverish us.
25 reasons protectionism is taken seriously
Given that background, here are my top 25 reasons that explain why protectionism is taken so seriously, despite the fact that it’s guaranteed to impoverish our economies and destroy jobs:
Politics over economics
Taken together, the 25 reasons above help us understand the popularity of protectionism, despite the fact that it’s guaranteed to inflict great economic harm. Protectionism is popular primarily for political reasons, not economic reasons. When politicians can count on the economic illiteracy of the general public and their blind patriotism to empty slogans like “Buy American,” the political payoffs from protectionism are too tempting to ignore despite the reality that it’s a form of economic suicide. And because the benefits of tariffs to producers (and jobs created or saved) are concentrated, immediate and visible, while the costs to consumers (and jobs lost) are diffused, delayed and invisible, it’s pretty easy to understand why protectionism is popular, even though the economic costs far outweigh the economic benefits and it’s therefore ultimately a form of self-inflicted economic poison.
On the 200th anniversary of comparative advantage, we owe a great debt of gratitude to David Ricardo for greatly advancing our understanding of international trade. In the textbook I use to teach Principles of Economics, the authors (James Gwartney et al.) refer to it as the LAW of Comparative Advantage, not just the “theory,” and say that comparative advantage is “universal as it applies across individuals, firms, regions, and countries.”
As one of the core laws of economics (along with the laws of supply and demand), comparative advantage helps us understand the way the economy and trade work. And that understanding of trade helps to advance free market principles and helps us appreciate that “free market capitalism is the best path to prosperity” as my friend Larry Kudlow often says.
Unfortunately, once we introduce the inevitable influence of politics into the picture we often move away from the best path to prosperity down a road that makes us worse off.
To quote Thomas Sowell: “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.”
And that’s the danger. That politicians will disregard the proven advantages of free trade that we learned from Ricardo 200 years ago, and protect domestic producers at the expense of the consumers and to the overall detriment of society and the general welfare.
To close, let me share some words of wisdom from another great 19th century economist – the French economist Frederic Bastiat – who framed the tension between producers and consumers very well:
“There is a fundamental antagonism between the producer and the consumer. The producer wants the goods on the market to be scarce, in short supply, and expensive. The consumer wants them abundant, in plentiful supply, and cheap. Our trade laws usually take the side of the producer over the consumer, of high prices over low prices, of scarcity over abundance.
It is necessary to always view economics and trade from the viewpoint of the consumer. All economic issues and trade policies must be judged by the advantages and disadvantages they bring to the consumer…. everything finds its meaning in the consumer, for the consumer represents mankind.”
In conclusion, if we can all agree that we want greater prosperity for mankind, then we can all agree to fight for consumers and free trade, and oppose protectionism.
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Tim WorstallHow foreign competition helps domestic firms
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