… is from page 140 of Paul Krugman’s Fall 1987 Journal of Economic Perspectives article, “Is Free Trade Passé?“:
A country cannot protect everything and subsidize everything. Thus interventionist policies to promote particular sectors, whether for strategic or externality reasons, must draw resources away from other sectors. This substantially raises the knowledge that a government must have to formulate interventions that do more harm than good.
Consider first the case of strategic trade policy. When a particular sector receives a subsidy, this gives firms in that sector a strategic advantage against foreign competitors. However, the resulting expansion of that sector will bid up the price of domestic resources to other sectors, putting home firms in these other sectors at a strategic disadvantage. Excess returns gained in the favored sector will thus be offset to at least some extent by returns lost elsewhere. If the government supports the wrong sector, the gain there will conceal a loss in overall national income.
DBx: As I read Adam Smith, his case for a policy of free trade was not based on any belief in the ‘perfection’ of markets but, rather, on his understanding that markets are superior to political interventions. To promote economic growth, free trade – compared to protectionist interventions – works better as a rule and over time.
The fact that someone might identify a few real-world instances of free-trade’s ‘failure’ or of protectionism’s ‘success’ does not, from the Smithian perspective, weaken the the case for a policy of free trade. Even less is the case for a policy of free trade weakened by a theoretical ‘proof’ that conditions can be described under which protectionism improves upon free-trade outcomes.
While some economists since Smith might have endorsed free trade because of its alleged ‘optimality’ or ‘perfection,’ all of the scholars whose writings on trade that I’ve studied – scholars such as Bastiat, Henry George, William Graham Sumner, Frank Knight, each of the Austrians, Milton Friedman, William Allen, Vernon Smith, Deirdre McCloskey, Pierre Lemieux, Razeen Sally, Russ Roberts, Dan Griswold, and Douglas Irwin, as well as my teachers Fritz Machlup and Leland Yeager – have followed in this Smithian tradition of assessing policies as rules rather than as actions taken in an institutional and timeless vacuum.
The case for a policy of free trade can no more be divorced from the reality that real-world government officials are unlikely ever to know enough to restrict trade ‘productively’ – and from the reality that government officials also are necessarily political creatures who respond to political opportunities and constraints – than can the case for a policy of not leaping off of the roofs of skyscrapers be divorced from the reality of gravity and from the reality that human bodies are not made of foam rubber.
But all this talk of optimality and institutions and rules and academic debates is typically beside the point when discussing or debating trade with politicians, pundits, and the public. Almost never do non-economists offer sophisticated arguments against free trade. Their errors remain as they’ve always been: childishly simple. Such apologists for protectionism simply overlook basic realities – realities such as the fact that resources cannot be transferred to industry X without being drawn from other productive uses, that imports are benefits and exports are costs, and that a country’s current-account deficit implies that that country is a net recipient of capital from the rest of the world.