28/03/2017 FreeTradeorProtectionism?

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CHAPTER 1: CAPITALISM: GOOD CAPITALISM

Free Trade or Protectionism?

One of the most pressing choices facing modern economies is whether to adopt a
policy of free trade or of protectionism, that is, whether to encourage foreign goods
into the country with minimum taris and allow industries to relocate abroad; or
whether to make it hard for foreign #rms to sell their goods internally and discourage
domestic producers tempted by cheaper wages in other lands.

It feels like a very modern dilemma, but the debates between proponents of free trade
and protectionism go back a very long way. The argument began in earnest in Europe
in the 15th century with the formulation of a theory known to historians as
mercantilism, the forerunner of what we today more colloquially refer to as
protectionism.

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Mercantilism was, like more or less every economic theory before and since,
interested in increasing a nations wealth. But it had very particular viewsabout how
this should be done. Mercantilists argued that in order to grow richer, a country had
to try to make as many things as possible within its own borders and reduce to an
absolute minimum its reliance on foreign imports. The role of government was to
help local industries in every sector, from food to textiles, machinery to agriculture,
by applying huge taris on imported goods and discouraging foreign manufacturers
from entering national borders and competing with local players. A strong country
was one that knew how to provide for itself and could achieve more or less total
independence in trade, a goal known as economic autarky.

The philosophy of mercantilism reigned supreme as the most prestigious and

persuasive theory of economics until the 9th of March 1776, the publication date of
possibly the most important book in the history of the modern world. In An Inquiry
into the Nature and Causes of the Wealth of Nations, the Scottish philosopher and
economist Adam Smith attempted to dynamite the intellectual underpinnings of
mercantilism.

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Smith argued that the best way for any country to grow wealthy was not to try to make
everything by itself, for no country could ever hope to do well in every sector of an
economy. By nature, Smith observed, countries had strengths in particular areas
some were great at making wine, others had talent in pottery, others still might be
experts at making lace and it was on such strengths that every country should focus.
It would be grossly inecient, observed Smith, for any country to attempt to be good
at everything; far better to zero in on areas of expertise sectors in which the country
enjoyed what Smith called an absolute advantage and then exchange those goods
and services with those of other countries. As Smith put it: If a foreign country can
supply us with a commodity cheaper than we ourselves can make it, better buy it o
them with some part of the produce of our own industry employed in a way in which
we have some advantage. The general industry of the country will not thereby be
diminished but only le' to #nd out the way in which it can be employed with the
greatest advantage.

This was an application at the level of nations of a theory we can understand well
enough at the level of individual life. If someone has a natural aptitude for
accountancy, it makes no sense for them to spend a considerable part of each day
trying also to make cheese, to sew their own trousers or to learn to play violin sonatas.
Far better for the accountant, cheesemaker, tailor and violinist to specialise in the
areas in which they each have the greatest advantage and then trade with others to
satisfy their remaining needs. As Smith noted: It is the maxim of every prudent
master of a family, never to attempt to make at home what it will cost him more to
make than to buy.

Smith emphasised that if Britain could produce woollen goods more cheaply than
Portugal and if Portugal could produce wine more cheaply than Britain, then it would
be bene#cial to both parties to exchange the product they could make at a lower cost
for the one they could only make at a higher cost. Slightly counter-intuitively, both
countries would get richer, for as Smith insisted trade was not a zero sum game:
the overall wealth of both countries would rise as both exchanged goods in the area of
their greatest advantage. In such a system, labour and capital would always be
optimally employed, directed to those sectors where native skill and opportunity was
at its greatest.

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Smith understood the tendency of politicians and the public to resist such
competition especially when it came from abroad and to fall prey to interpreting
its eects as a form of robbery or job destruction. But he insisted that the well-
meaning attempt to shelter inecient local producers would always end up
impoverishing a country, and hurting its most vulnerable members, because it would
prevent labour and capital from playing to their strengths, would make goods far
more expensive than they needed to be and would discourage leading companies from
a necessary intensity of innovation. The job of the government was to recognise
sectors where there was a national advantage, assist in the education of the workforce,
but otherwise, reduce taris as much as possible, and step out of the way.

With astonishing speed, Smiths theory convinced most of the economic and political
classes of north Western Europe. In Britain, his ideas were #rst put to a practical test
in relation to the primary foodstu of the nation: corn. Grain prices had, for many
years, been protected by government decrees. Cheaper foreign grain had been kept
out, apparently in order to protect jobsand national wealth. But Smiths ideas, now
driven forward by his foremost discipline David Ricardo, proposed that all taris on
imported grain protectionist measures known as the Corn Laws were in fact
obstacles to economic growth. A'er bitter debates in Parliament, the laws were
repealed in 1846. The result demonstrated to perfection both the advantages and
incidental costs of Smiths ideas: the price of corn dropped sharply, the shopping
basket of British consumers tumbled in price and everyone, especially the working
classes, had a lot more spare money to spend on other goods, which grew the overall
size of the British economy, so that it signi#cantly outperformed all of its European
counterparts. But and it was a very big but large swathes of British agriculture also
went to the wall. Cheap imported corn, largely from Canada and the mid-western
United States, destroyed farms and ways of life that had persisted for centuries. The
agricultural class, which had been enormously important to the economy, became
negligible, both in terms of how many people it employed and how much wealth it
created. There were for a time pockets of deep unemployment in the rural sector.
Smiths theories were both correct and, depending on where one was standing, plainly
agonising.

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An enduring problem for the undoubtedly very sound arguments in favour of free
trade is that its costs have seldom been addressed with sucient passion and
ingenuity. The cries of the dispossessed have not been recognised for what they are:
threats to the entire stability and moral dignity of a nation. As has only gradually and
#tfully been realised, the bene#ts of an open economy can only properly bear fruit if a
series of steps are taken to mitigate the attendant downsides. Any nation committed
to free trade must tax the sectors of the economy which have an advantage right up to
though never beyond the point where this advantage would otherwise be eroded
and then use the money to retrain those suering in the sectors of the economy with
the gravest disadvantages in relation to foreign competition. Without such
redirection, a nation will become highly unstable politically thereby endangering
any progress that free trade has made. Secondly, governments must enable everyone
in the economy to #nd their own natural areas of strength; which means in plainer
language high levels of investment in education and a ra' of measures to maximise
social mobility. Monopolistic behaviour by the rich can endanger the integrityof the
free trade system no less than can punitive taris or import duties.

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Intellectually, free trade has undoubtedly won the argument. It is plainly evident that
countries should not put up taris, that each country should trade goods and services
where it has its advantages, and then allow imports to come in and if necessary
decimate local industries where it doesnt. When a Mexican worker can make a car for
eight dollars an hour, whereas an American one costs58 dollars an hour, it is clearly
wise to allow Mexico to do what it can do best, whatever the eect on American car
workers. However, defenders of free trade have been grossly negligent when it comes
to arguing for, and instituting the political programme necessary to support the
ecient operations of the system. It has forgotten the pain of the car workers, the coal
miners and the steel makers. And, in democracies, there has been a heavy price to pay
for this neglect, in the form of the rise of a new class of mercantilists, who have
successfully argued that barriers must again increase, that a country should make
everything within its own borders to regain its greatness and that cheap importers are
invariably the destroyers of domestic jobs.

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These arguments make no sense, but so long as the proponents of free trade fail
properly to articulate a programme to remedy free trades operations, whole nations
will be seduced by the bromides of the mercantilists and will suer accordingly until
the distinctive wisdom of Adam Smith can once more reassert itself.

How to Enrich a Country: Free Trade or Protectionism?

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