Free Trade - Still a Good Idea?

Back in the far off days when I was studying Janet and John economics (actually An Introduction to Positive Economics, by Richard Lipsey, followed by various others) there were several standard subjects that students had to write essays on. One was the effect of changes in exchange rates on the UK economy, and one of the others was a discussion about Free Trade and the theory of Comparative Advantage. Comparative Advantage is one of the fundamental arguments for Free Trade, so let me explain. At it simplest, suppose Janet and John both produce widgets and floggle-toggles. If Janet is more efficient at producing widgets, and John better at floggle-toggles, then it makes sense for Janet to concentrate on widgets, and John floggle-toggles, selling them to each other. The theory is that each is cheaper, they all make more of them, and everyone is happy. Taken to it’s limit, Free Trade between countries should result in everyone being better off and more prosperous. Of course, Janet and John are countries, and it’s a lot more complicated than that (it always is!).

So why would you want to control trade between such countries. Well, there’s lots of reasons. Here’s some:

Strategic/military - you may not want to buy all your weapons and ammunition from a country you may end up being at war with. Balance of Payments - If widgets are much more expensive that floggle-toggles, John could end up owing Janet a lot of money Employment - if floggle-toggles involve a lot more labour to make than widgets Janet Country could end up with mass unemployment, whereas John Country would be prosperous

Again, it’s much more complicated than that because nothing stays constant. But it’ll do for starters.

So you might want to control imports and exports in some way. This might be to protect local industry, simply as a method of raising tax, or as an economic weapon against countries we disapprove of. Duty on brandy, for example, has been used for the last two.

Tariff Barriers - Janet charges import duty on some categories of goods. John may retaliate by doing the same. NOTE it isn’t a case of John refusing to sell goods to Janet, as some politicians seem to suggest Quotas - John limits the number of widgets that can be imported in any year. Outright Bans - Janet may not want to sell any nuclear missiles at all to her unstable cousin. Currency controls - Janet wants to go on holiday but can only take a limited amount of money out of the country, or can only spend so much on floggle-toggles. Subsidies - instead of making widgets more expensive by slapping duty on them, John subsidises home made widgets so they are cheaper. This subsidy is paid out of taxes in some way.

For quite a while, Free Trade worked well for us. We could import raw materials, convert them into manufactured goods and sell them back to the countries we go the raw materials from. Things are a bit different now. Capital, in the form of multi-national companies, can move around the world to almost any country where the cost of production is cheapest. And people can move too. Not just cheap labour coming to the UK to do jobs that we Brits don’t want to do, but scientists, designers and creators of things can too. It was great that some Brits won Nobel prizes for science recently, but they did it working in the U.S.A. The UK won’t get much benefit from that.

The reason that the City of London is a major world force in financial services is that is was the hub of an Empire on which the sun never set. Services tend to follow where stuff is manufactured, and where commodities are traded, so we can’t guarantee that our service companies will always continue to be world leaders. They may, but the majority of their business, employment and profits may end up elsewhere.

To go back to the earlier analogy, it’s as if Janet and John moved their money to Timothy’s country. They make a little more profit that way, but the tax and employment are now in Timothy’s country, not theirs.

The plan in India is for them to dominate the provision of services in the English speaking world. It is expected that China will dominate world manufacturing. It is just so much cheaper to do it there. The trend will continue until wages rise in those countries so that costs are roughly equivalent to ours. We may not be importing many Chinese cars yet, but you can bet your life we will before too long. We already import cars from Malaya and Korea - an idea that would have been laughed at in the 60’s.

Yes, there will be niche markets and brands we can exploit, where normal ideas of value and cost are outside the norm - Barbour, Burberry, Rolls Royce and Bentley (both now German owned, of course), and Jaguar (Indian) are examples. We may even get away with BMW’s Mini as being a totemic British brand. But we need to make a heck of a lot of these to provide employment for us all. And the wealth of international companies may be squirrelled away elsewhere so that the UK doesn’t get the benefit of tax on their profits.

Don’t get me wrong - I’m not calling for Fortress Britain. In the 60’s, we still had subsidised and protected industries, and this resulted in cars that fell to bits, TV’s that didn’t work when delivered, and airplanes that no-one else wanted to buy.

I’m just saying that we have to be careful what we wish for.

Footnote: At the moment, there are still major benefits in concentrating manufacturing as much as possible, working three shifts, with as little labour input as possible. Eventually, the labour costs may not vary that much anywhere in the world as they become an insignificant part of the overall cost. Also, 3D printing technology could completely change the way things are made over the next 50 years. You might like to think about the implications of that!