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Discourses On Trade

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An acquaintance recently wrote the following to me by e-mail:

I was asked if it would be in the interest of the US that we lease a large tract of land to a foreign gov’t, allow them to bring in workers, build manufacturing plants, exempt them from US labor, environmental and other regulations  and task them to build labor intensive products. It could be cars, barges, tractors, whatever. It would be understood that domestic industry would suffer or even ruined but the prices would be lower. Perhaps even lower than if the product were made in China (or wherever) as transportation costs are eliminated.

If this is to the advantage of the US, why not propose it. If it is not to the advantage of the US, what is different in concept between this and the free trade agreement w Korea? I wasn’t sure that my answer was satisfactory. So, I thought that I would ask you.

The proposal of a hypothetical special economic zone within the U.S. is a red herring (although I will likely, in a follow-up post, say more about it).  What’s really being asked is why should Uncle Sam permit Americans to trade freely with non-Americans who – because these non-Americans’ costs of production are supposedly lower than are the costs of their American competitors (due to the non-Americans’ exemption U.S. regulations) – can underprice American producers.

Although straightforward, there are many layers to this question.  By “many layers” I do not mean that the answer to the question is ambiguous; it isn’t.  The answer (as I will explain) is unambiguously that Uncle Sam will make Americans as a group poorer by restricting Americans’ freedom to spend their money on these foreign products.  But explaining just why this answer is unambiguously correct can, and should, be done at different levels of economic sophistication.  I will do each ‘level’ in different posts.  In this post I do level one.

Level One: It doesn’t matter why foreigners’ costs of production are lower than are American producers’ costs of production.  If the cost incurred by foreign firms to produce, say, steel is lower than is the cost incurred by American firms to produce steel, then the cost to us Americans of acquiring steel is lower if we purchase it from foreign firms than if we produce steel in America.  The U.S. government would make Americans, as a group, poorer by denying us the opportunity to acquire steel at the lowest possible price on the global market no less than it would make Americans, as a group, poorer by denying us the opportunity to acquire steel at the lowest possible price on the domestic market.

Most people agree that if ABC Co. in Texas produces steel at a lower cost (and, hence, sells steel at a lower price) than does XYZ Co. in Ohio, Americans, as a group, would be made poorer by a tariff put on Americans’ purchases of steel sold by ABC Co.  Most people understand that the unquestioned benefits that such a tariff would bestow on shareholders and bondholders of XYZ Co., as well as on many workers in Ohio, would be smaller than are the resulting losses to American steel consumers.  And almost as many people would also agree that nothing is amiss if the reason for ABC Co.’s lower cost is (say) a preference of Texas workers to take a higher portion of their compensation in the form of wages rather than in the form workplace safety that is as high as is the level of such safety preferred by Ohio workers.

Nothing about political boundaries changes the above economic logic.  If workers in China, India, and Brazil – as compared to American workers – prefer to take a larger portion of their compensation as wages relative to workplace safety, and if this preference allows producers in China, India, and Brazil to produce outputs at lower costs than their American rivals, there is no good reason for Americans to object.  Such a willingness on the part of these foreign workers is no less a genuine source of comparative advantage for them and their employers than would be, say, their and their employers’ access to richer mines of ore or to unique work skills.

Of course, those producers who lose market share to rivals nevertheless complain and make excuses – and, too often, seek from government special protection from competition.  The fact that foreigners are more easily demonized than are fellow citizens, and the fact that too many people think only in the most shallow way about the economics of international trade, make it far easier for firms to get special protection from competition when their rivals are foreign than when their rivals are domestic.  But as careful readers of this blog know, one of the great lessons of economics is that there are no fundamental economic differences that distinguish domestic trade from international trade.  Any problem, real or imagined, that someone identifies as a reason for restricting trade with foreigners is a problem that looms within patterns of exclusively domestic trade.

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It will be objected that it’s unfair for American producers to compete with foreigner producers because American producers’ costs of production are made artificially high by U.S. government regulations.  I’m the last person to deny that U.S. government regulations are unjustified and that they often unjustifiably raise U.S. firms’ costs.  But before addressing this issue, it’s important first to say a few words about legitimate sources of differences in costs.

If (say) the U.S. government’s workplace safety rules are justified, then this fact means that these rules reflect Americans’ preferences (or at least the preferences of most Americans).  There is nothing objectively right or wrong about any particular preference for workplace safety.  (It’s uncontroversial that workers’ demand for such safety changes over time, usually increasing as workers become wealthier.  This pattern is found in American history.)  But because workplace safety is not free, if workers (either directly or through legislation) successfully oblige employers to supply more such safety, the workplace-safety component of firms’ costs will rise.  If this higher cost is not offset by resulting lower costs or greater benefits on other margins for firms – say, by wages lower than otherwise, or by higher worker productivity – then indeed these firms’ costs of production will be made higher by their obligation to supply greater workplace safety.  But these higher production costs are not illegitimate or unfair; they reflect American workers’ preferences for safety no less than they reflect American workers’ preferences for leisure.

Such higher production costs might well make it impossible for some American firms to compete successfully against foreign rivals who have access to a labor force with a less-intense preference for workplace safety.  But this fact is fine, for all it means is that those foreign rivals (who, say, produce steel) have a comparative advantage over their American rivals in the production of steel.  These foreign firms can produce steel at a lower cost than can their American rivals and, hence, we Americans are made richer if we switch our production to those tasks for which we have a comparative advantage and use the resulting proceeds to purchase steel from foreigners.  (In a follow-up post, when I discuss another level of this matter, I will explain how the principle of comparative advantage [2] renders silly the oft-heard concern that Americans’ higher costs of production enable foreigners to ‘outcompete’ us at everything.)

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But what if U.S. government regulations do indeed impose economically unjustified costs on U.S. producers?  For example, what if U.S. government regulations force U.S.-based firms to supply a level of workplace safety that is higher than American workers really want?  Does this possibility (which I believe to be quite real) justify the imposition of special taxes on Americans who choose to buy lower-cost imports?  Because this post is already too long, I’ll answer this question in a follow-up post.

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