Here are the first two installments of a series of eight explaining something important that few people understand. The subject of protectionism is important because the concept is intuitively appealing and its implementation a recipe for poverty.
I hear more and more talk of protectionism, not only on the left where you would expect it, but among conservatives as well. “Protectionism” refers to any government policy intended to impede or slow down imports, merchandise and services produced somewhere else. The main idea behind protectionism is to “protect” the jobs of domestic, local workers. The idea goes like this: Americans need shoes. If you stop foreign shoes from coming into this country, Americans will have to make shoes for Americans. That means more jobs.
That’s an attractive idea and one that’s easy to grasp. Unfortunately, protectionism is actually the royal path to poverty. Even more unfortunately, the reasons are difficult to explain. You have to rely on counter-intuitive explanations to show why protectionism actually makes people poorer. Roughly, the reverse of protectionism is called “free trade.” (What is meant here is free international trade.) International trade simply means trade of merchandise and/or of service that crosses national boundaries: A pound of oranges grown in Mexico and sold in the US is an import.
On a more personal note, I think that the inability to explain why protectionism is bad, to explain the virtues of free trade, is one the signal failures of American academia. Here is something that all scholars agree on, that’s important, that people are unlikely to figure out on their own, and it’s not getting through. I have known reasonable good students who had taken two courses on the topic as undergraduates, one more in an MBA program, and who still did not understand the relevant basic ideas. So, it’s a mission of mine to try and do it. I am going to try to use this blog to explain the economic logic of free trade, one small step at a time.
First of all, let me say that I will not tell you anything controversial among economists. Again, they all subscribe to what I am going to tell you whether they are liberals or conservative.
Here are the first, central ideas. There are several reasons why there is any international trade at all. I want to talk only about the two most important. Feel free to use the Comment mechanism to ask questions about other reasons.
1 There are many trucks, cars and motorcycles in India and almost no petroleum production. Indian economic actors, directly and indirectly, bring foreign oil into India to serve the needs of Indian drivers. This is easy to understand. There is nothing counterintuitive about this. Unfortunately, in most years, this explanation does not account for most international trade. We have to consider the second, difficult explanation. (Incidentally, note that in the example above, it is incorrect to say that “India imports oil.” It’s said all the time as a shortcut but it’s factually wrong. I think it’s also very misleading. More on this latter.)
2 The second main explanation for the existence of international trade is best understood by leaving for a while anything having to do with trade, international or domestic. I ask you to follow me tiny step by step. Any step you don’t understand, stop. People regularly overestimate themselves in this exercise.
I have two jobs. In the my first job, I earn $10 an hour washing dishes. I do it for thirty hours a week, grossing $300. In my second job, I sell junk at the flea market. After taking care of all the costs involved, I earn $30 an hour on the average at this second job. I only go to the flea market on Sundays when the restaurants where I work is closed. I spend six hours there every Sunday. My flea market job thus gets me $180. Altogether, between the two jobs, I earn $480 a week.
I decide to change my work some. I negotiate with my restaurant boss to work there only fifteen hours a week. My total restaurant pay is reduced to $150 as a result. I go to work at the flea market Friday, Saturday and Sunday, a total of 18 hours. That brings my flea market earnings to $540. With this new arrangement, I now earn each week: $150 + 540 = $690.
Now stop everything and consider the following statements:
A I earn much more money now than I used to. I gave myself about a 50% raise, something that does not grow on trees;
B I don’t spend more time at work. (I spend less.)
C I did not get this improvement in my earnings by cheating anyone. It’s unlikely that anyone is poorer as a result of my higher earnings.
D The more money I make, the more stuff I can buy,
All four statements are true. If you don’t believe it, go over the whole exercise more slowly. All the numbers involved are simple and small. You may need a single piece scratch paper and a pencil. If you still don’t agree to all four statements, write me in a Comment.
Once we have this under control, I will move on slowly to another piece of the free trade puzzle.
The summary so far is this:
If I do less of what does not reward me well and I do more of what rewards well, I am better off.
This guy Luis who lives across town make his living blowing off leaves and taking garden debris to the dump. On the average, he earns $7 an hour at this occupation. He works forty hours a week for a total weekly pay of $280.
Luis decides to quit this ill-paid job to go wash dishes in a restaurant for $10 an hour. (Any restaurant, it does not matter which restaurant.) There, he also works forty hours a week. His new pay is $400. Luis gave himself a 40% pay raise. He does not work any longer. His new job is probably not harder than the old one. He did not cheat anyone. He has more money to buy stuff. He is also in a better position to work less, to lay about, go to school or attend to his high-maintenance girlfriend. If he decides to work only 35 hours a week for example at his dish-washing job he will still be ahead: he will learn $350 a week instead of $280 previously.
Stop here and consider the two first steps I described (Part One and Part Two): Both Luis and I improved our earnings, not a little bit, a lot. We don’t work more than we did before. No one got cheated. There is no miracle. Luis and I just switched from work with bad pay to work with better pay. Each of us became more productive. We are both more able than we were before to buy stuff, to laze about, or to improve again our productivity by taking classes, for example.
You may ask who is blowing off the leaves now. Fair question with which I will deal later. If I don’t, remind me. The answer has to do with escalators.
[Part 3 can be found here. ]