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More Vérité from Veronique on Trade

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The Mercatus Center released today a new paper by the intrepid Veronique de Rugy on the so-called “new protectionism.” In this excellent paper, Vero examines several assertions meant to protect protectionism from the clarifying acid of economic analysis [2]. Vero patiently and clearly explains that arguments for protectionism continue to be as flawed and untenable as they have been since the beginning of time.

Here are two slices (but do read the whole paper [2]):

Open economies grew faster than closed ones. A recurring finding of economic research is that open economies have historically exhibited better economic performance in countries at all levels of development; increased the standards of living of consumers, producers, and workers alike; and lifted millions out of poverty. In a report titled “Why Open Markets Matter,” the Organisation for Economic Co-operation and Development explains that “relatively open economies grow faster than relatively closed ones, and salaries and working conditions are generally better in companies that trade than in those that do not. More prosperity and opportunity around the world also helps promote greater stability and security for everyone.”

Hong Kong never had and still doesn’t have protectionist policies in place. Singapore, apart from an experiment with low-grade import protection, has embraced free trade. Yet both Hong Kong and Singapore grew rapidly and are today among the most prosperous economies in the world. Hong Kong is a case worth highlighting. Thanks to its history of free trade under British rule and its current special status in China, Hong Kong is widely regarded as one of the least restrictive economies in the world. Among the policies that have fueled its growth is unilateral free trade.

In 1950 Hong Kong’s average per capita income was about one-third the average per capita income in the United States, but by 2017 Hong Kong’s was slightly higher. In 1960 life expectancy in Hong Kong was three years shorter than in the United States, whereas by 2017 it was five years longer. While free-market policies in addition to free trade contributed to Hong Kong’s economic success, at the very least unilateral free trade hasn’t prevented Hong Kong’s transformation into one of the richest economies in the world.

It is common knowledge that China heavily subsidizes some of its favored industries. As the conventional wisdom goes, government support allows the state firms to produce goods at artificially low costs, which translate to artificially low prices. These subsidized foreign producers gain substantial market share in the US market, destroying US jobs. Americans are told that retaliatory measures are necessary to correct this imbalance.

There are two fundamental errors with this argument. First, the benefits from trade come in the form of imports, and exports are the means of obtaining these benefits. Second, most of the cost of these subsidies is borne by the people of China.

As Paul Krugman has written, “All that matters for the gains from trade are the prices at which you trade — it makes absolutely no difference what forces lie behind those prices.”

The people on whom the burden of government subsidies fall are the citizens of the government that does the subsidizing. The Chinese subsidies, for instance, are a tragedy for the people of China because they inevitably divert resources away from nonsubsidized areas of the Chinese economy. This means that there are many industries in which China isn’t producing — or isn’t producing as much — because its government arbitrarily subsidizes other areas of the economy.

The lower prices of Chinese imports made possible by Chinese government subsidies work mainly to the benefit of China’s trading partners, including the United States. Contrary to common belief, the real benefits of trade are measured by the value of imports that can be bought per unit of exports — in other words, the exports’ purchasing power. The lower the price of imports, the better it is for the importer, even if the price is low only because of a foreign government’s subsidies. Furthermore, 63 percent of US imports from China are intermediate goods used for the production of other goods and services. The Chinese government is, in effect, subsidizing a large number of American producers.