Less-Expensive is Good; Costless Would be Even Better

by Don Boudreaux on October 5, 2004

in Trade

Suppose a housewife one day accidentally discovers that a gallon of tap water combined with a dash of salt, a pinch of flour, a drop of ammonia, a splash of cooking oil, and tiny bits of several other ordinary kitchen ingredients will produce a concoction that cleans and sanitizes dishes, clothing, countertops, sinks, windows, automobile exteriors and interiors, household pets, and infant children. It also is astonishingly effective at fighting cavities, whitening teeth, and keeping gums healthy – and it keeps breath fresh for 24 hours. This remarkable all-purpose cleaner is 100% safe and totally effective. The cost of producing each gallon of this stuff is $0.02.

Further, in a fit of magnanimity, this resourceful woman publishes her finding on the Net, free of charge.

Several large corporations are devastated, for no longer will families spend money buying laundry and dish detergent, window cleaner, baby wash, toothpaste, and breath fresheners. Thousands of workers who “played by the rules” lose their jobs with the firms that produced now-obsolete products such as Windex, Tide, Cascade, Fantastik, Gleem, and Listerine.
……

Now change the example just a bit. This housewife makes this discovery but, in a fit of self-interestedness, she keeps the concoction secret and starts producing it herself, selling it retail at, say, $5.00 per gallon. Its popularity is immediate and immense. She makes a fortune – and in the process devastates the likes of Colgate-Palmolive, Lever Brothers, and Johnson & Johnson no less than these firms would have been devastated had she given her secret away free of charge on the Internet.

Which scenario is the better one, judged from the perspective of “social” welfare? In my view, the first scenario is much better than the second. But surprisingly, judging from discussions of international trade, lots of people think that the second scenario is better – indeed, many people think that the first scenario is catastrophic.

When I discuss international trade with my students, I point out that foreigners sell things to Americans only because and insofar as they want to buy things (including financial assets) from Americans. I’m easily able to demonstrate that the dollars Americans spend on imports return to the U.S. economy as demand by foreigners for U.S. exports and assets. Upon seeing this full picture, my students breathe a sigh of relief, aware that, ultimately, no jobs are lost because of foreign trade.

“But suppose,” I then ask, “that foreigners start sending valuable goods and services to us free of charge.” I emphasize that this hypothetical won’t happen in practice, but I ask “would it be good if it did?”

I’m always disappointed in the consensus answer of the class: NO!

“Why ‘NO’?” I ask, with undisguised horror.

The answers all come down to this: students can see that dollars used by consumers to buy things will be spent by the sellers on some other dollar-denominated goods, services, and assets. But students do not readily see that the dollars that consumers do not have to spend now on free goods and services shipped from abroad will be spent elsewhere. If I no longer have to spend the approximately $70 per year that I now spend on dishwasher detergent, I’ll spend that $70 per year buying other goods, services, or assets.

When I explain this fact to my students, they eventually get it (or so I fancy). But the very need to have to explain carefully that valuable goods and services offered free – or at lower and lower prices – are a benefit to society and not a problem reveals the challenge that right-thinking people confront when debating protectionist demagogues.

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