The Beauty of Free Trade and the Dangers of Protectionism

One of the focal points of President Trump’s campaign was trade, specifically criticizing the North American Free Trade Agreement (NAFTA) and the Trans-Pacific Partnership (TPP) trade deals. Trump cited the huge deficits and loss of manufacturing jobs as evidence that the trade deals were hurting the U.S. Throughout his campaign he proposed placing tariffs on foreign countries, even to the extent of placing a 45% trade tariff on the U.S’s largest trade partner, China.

Trump’s position against free trade extends further than just campaign rhetoric to appeal to his supporters. In December, Trump chose Peter Navarro to lead a newly formed White House National Trade Council. Navarro is known for his negative perspective on China when it comes to trade; he has authored a book called “Death by China: Confronting the Dragon – a Global Call to Action.” It’s therefore no surprise that one of the first executive orders from Trump was to withdraw from TPP.

Furthermore, one of Trump’s focal points during the campaign was his promise to build a wall along the Mexican border and make Mexico pay for the wall. However, the Mexican president has refused to pay for the wall. In January, the White House stated that Trump is contemplating placing a 20% tariff on imports from Mexico in order to fund the wall. Finally, a senior Trump transition official said in December that the Trump team is discussing placing a tariff of 10% on all imports. This is after Reince Priebus – the current White House Chief of Staff – had suggested placing a 5% tariff on all imports in meetings with people in Washington.

Yet, free trade has been fundamental to the growth and prosperity of the world’s economy and the U.S.’s economy. In order to understand why free trade increases the GDP of all the countries involved in trade, one must understand the basic economic theory behind free trade. The first economic philosophy on trade was established in the 17th and 18th century, in Europe, called mercantilism. The Mercantilists believed that a country becomes rich and prosperous by exporting more than they import. Thus, governments should discourage imports and encourage exports in order to increase its amount of money (in those days, gold). With more gold, a country can have a larger army which would enable it to expand their empire. However, this is not the correct way to measure the economic success of a country. The level of consumption and standard of living a country is the optimal way to gauge the success of an economy.

Adam Smith first discovered the notion that for two nations to trade both must gain. Both nations gain based on the idea of absolute advantage—a country is more efficient in producing a commodity than another country. For example, Country A can produce one hundred computers but only fifty bicycles an hour, while Country B can produce fifty computers and one hundred bicycles. If each country specializes and produces the commodity it has an absolute advantage in—for Country A that would be computers, and for Country B, bicycles—and produces enough to export that commodity while importing the commodity it has a comparative disadvantage in, both countries will be able to consume more than they would have if they hadn’t traded.

Later, David Ricardo published “On the Principles of Political Economy and Taxation” in which he explains the idea of comparative advantage. Even if a country is more efficient in producing both products than the other country, both countries can still increase their consumption through trade. The less efficient country should produce the product that it has a smaller absolute disadvantage than the more efficient country. For instance, Country A can produce three phones and five boxes of cereal in an hour while country B can produce ten phones and eight boxes of cereal an hour; Country A should specialize and export boxes of cereal because it has a smaller absolute disadvantage in boxes of cereal (only half as productive as opposed to more than 1/3 less productive) than phones. Smith and Ricardo formulated the economic theory behind free trade and globalization, namely that countries will increase their overall consumption if they allocate their resources towards the commodities that they have a comparative advantage in and import items that they have a comparative disadvantage in. Despite the discoveries of the Smith and Ricardo, politicians and groups still propose the old mercantilist ideas usually due to high unemployment or a loss of manufacturing jobs.

Despite all the benefits of free trade, it does adversely impact the domestic producers of the commodity that is being imported, many times causing unemployment. However, the negative repercussions from imports on domestic producers of the imported commodity do not outweigh the positive net effect it has on the overall economy of the nation. Through trade, the nation is able to use its resources towards the production of the commodities that it has a comparative advantage in and is able to import items it has a comparative disadvantage in, thus increasing the country's overall consumption. But the negative effects on the producer is much more drastic than the benefits to the average consumer. The domestic producer can experience job loss while the average consumer is able to purchase more with his/her earnings because other countries can produce the imported items cheaper than the domestic producers can—the foreign country has a comparative advantage and, or, an absolute advantage in the imported item. This is why politicians, counter to basic economics, at times advocate protectionist policies because domestic producers of an imported commodity are much more likely to voice their distaste for free trade than the average consumer who is not likely to notice the benefits of free trade. Tariffs help the domestic producers of the imported commodity, yet the negative impact on consumer prices outweighs the benefits to the domestic producer causing deadweight loss—a loss of economic efficiency. Additionally, depending on how big the tariff is, it limits or eliminates the imported commodity forcing the country to take away resources from the commodity where it has the comparative advantage in and use it for the commodity that it has comparative disadvantage causing further deadweight loss.

The National Foundation for American Policy (NFAP) during the Trump presidential run calculated the effects of a 45% tariff on imports from China and Japan and 35% tariff on Mexican imports (things Trump has said during the campaign). It is highly probable that these tariffs on China, Japan, and Mexico will fail in protecting American industries. The NFAP collected data for thirty duty orders that the United States had placed on foreign countries, and the majority of the time it did not lower the total imports of the commodity that the U.S. restricted. This is because many other countries can either produce the same product or have substitute for the commodity, leaving no change in total imports. The NFAP then calculated if Trump decided to propose a 45% tariff on all countries because tariffs on Mexico, China, and Japan did not curb imports, he would essentially be placing a regressive tax on U.S consumers because people with lower income spend a larger percentage of their income on the commodities that are imported. Furthermore, the U.S. economy would experience significant deadweight loss. In a time like this, with politicians publicly calling for drastic policy changes, it is critical to reexamine some of the economic history and theory behind trade policies.